PART #A: CHOICE OF ENTITY1. Structure of Power2. Fiduciary Duties

a. Duty of Care: standard for business decisionsb. Duty of Loyalty: putting the corp. and s/h ahead of own financial interestc. Duty of Stockholders: majority s/holders owe a fiduciary duty

3. Voting

Factors in deciding choice of entity:1. Liability – who is liable for debts of business if business cannot pay?2. Control/ management – who controls and makes decision pertaining to business?3. Transferability of ownership interest – how easily can one’s stake be sold?4. Continuity of existence – how long can the business last?5. Taxation – how is the business taxed? (i.e. entity level tax, or flow-through tax)6. Raising addition capital – how easily can the business raise additional $$?

1) Sole Proprietorship (SP) Needs only 1 person and 1 business If more than 1 person in business then they are employees (agents) and the SP is

the principal No government filings required dba (doing business as) is the only form that would be required

1. Liability o SP is only person liable for debtso Unlimited personal liability b/c no distinction between person and businesso Worst form for individualo It’s not an entity so there is no distinction between the person and the

business’ assets o Insurance can insulate individual from liability

2. Control/ management o SP controls

3. Transferability of ownership interest o SP can sell the business but it must sell all its assets (i.e. IP – the business

name, equipment, client lists, etc.)

4. Continuity of existence o Business lasts as long as SP wantso Death, sale, or bankruptcy can end business

5. Taxation

o SP taxed directly on his tax situation b/c no distinction between business and person

o “Schedule C” 1040 tax form used to calculate SP loss/profito “Above the line” all expenses that reduce income tax for business expenses o “Below the line” watered down deductions based on income

6. Raising addition capital o SP can take out a personal bank loan

2) General Partnership (GP) GP is a consensual association 2 or more persons to carry on a business Governed by partnership agreement If no partnership agreement then governed by statutory provisions UPA and

RUPA (RUPA 103(b) mandatory provisions) UPA (default provisions): govern aspects of the partnership relation in the

absence of express agreement on those aspects. UPA (mandatory provisions): govern the relationship among partners that

probably cannot be varied by the agreement of the partners (i.e. fiduciary duty among partners, power of every partner to dissolve, unlimited liability of each partner, etc.)

No formal agreement required No written instrument required (handshake ok) RUPA § 202(a): not subjective intent of parties objective intent is required to

determine if parties intended to form a partnership. Look at surrounding facts and circumstances (i.e. profit sharing, written statements, testimony, circumstantial evidence). Combines UPA 6 and 7 – the addition of “whether or not..” merely codifies the universal judicial construction of 6(1). 202(b) provides that business organizations formed under other statutes (i.e. corp, LP, LLC) are not partnerships.

RUPA § 101(6)): Partnership: association of 2 or more persons to carry on as co-owners a business for profit formed under 202, predecessor of law, or comparable law of another jurisdiction.

RUPA § 101 (7): Partnership agreement: agreement among the partners concerning the partnership, including amendments to the agreement.

1. Liability o Each partner is jointly and severally liable for all debts even if that partner did

not incur the debto If one is required to pay they can sue the other partner for their contributiono UPA 7: newly admitted partnerso RUPA 306(b): newly admitted partnerso RUPA 405: a partnership may maintain an action against a partner for a

breach of the partnership agreement, or for the violation of a duty to the partnership, causing harm to the partnership

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o Malpractice insurance can insulate individual partnerso Recourse only assets of company and not each party but that is a provision

that the 3rd party must agree too RUPA 303: statement of partnership authority delineates the authority of

each partner to bind the partnership o Legal distinction between partner and individual a creditor cannot attack

partnership to seize for personal debt but can seize their shares in the partnership

o 303 is new. The most important goal of the statement of authority is to facilitate the transfer of real property held in the name of the partnership.

2. Control/ management o Partners controlo UPA 18 (e) and RUPA 401(f): all partners have equal rights unless the

partnership agreement states otherwise. o RUPA 401(i): a person may become a partner only w/ the consent of all of

the partnerso RUPA 401(j): in the absence of an agreement to the contrary, matters arising

in the ordinary course of the business may be decided by a majority of the partners.

3. Transferability of ownership interest o General rule: A partner can transfer his financial interest b/c its personal

property. Transfer does not pertain to managerial control unless partners decide otherwise. Partnership agreement must specify terms.

o UPA 27(1) and RUPA 503 (a) and (b): a partner can, by default, transfer his interest to a 3rd party but that is only the beginning of the analysis. Financial rights to receive distributions of $$ and allocation of profits and losses for tax purposes are transferable to 3rd party

o RUPA 502: financial interests are considered personal property. Only if all partners consent can 3rd party become an actual partner and enjoy managerial control befits

o UPA 18(6): partnership agreement may lower managerial threshold.o Hypo: if someone sells partnership interest, who gets managerial control after

that person dies? The managerial aspect remains w/ the transferor o Hypo: who has joint and several liability for debts? The person w/ financial

interest – the transferor – follows the managerial control aspects of partnership interest. Joint and several liability stays with the transferor.

o Policy: person in control making decisions should be liable (accountability)o RUPA 503 (d): makes clear that transferred interest is only $$ and transferor

retains management interest and is personally liable for all partnership obligations

o Most agreements require that the partnership must buy back interest

4. Continuity of existence

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o Generally partnership lasts until events of dissolution (death of a partner, completion of project, specified date) UPA 29. If no partnership agreement then UPA and RUPA refer to events which dissolve partnership. Dissolution automatically triggered upon an event. Partnership not terminated, but relationship between partners changes. Partners must agree to new partnership.

o Dissolution: the first phase of the termination process (NOT a termination). It merely ends the carrying on of the business in that partnership. (according to UPA - a change in legal status)

o Winding up: the second phase of the termination process which is the moment at which the event that sets termination of the business in motion (i.e. paying off debts, settle its contracts, find purchaser for capital, etc.) (according to UPA – describes the economic event of liquidation that follows dissolution)

o Termination: the final phase of termination is complete once the winding up phase has been completed and all partners have agreed upon termination

5. Taxation o Flow-through taxation: the partnership is not taxed. All income and expenses,

gains and losses, are taxable directly to the owners. Based on allocated profits or losses.

o IRS form 1065: informational tax return – allocation of profit or loss of each partner claimed on line 17 of personal tax form 1040

o Schedule k- 1: tells each partner their allocation of loss or profit to report on 1040. If there is a loss then it offsets income

o Problem w/ flow-through taxation: pays out your allocated share, not what is actually paid out. If entity decides to invest profits instead of distributing, the partner still has to pay taxes. To avoid, the partner can include a provision in the partnership agreement that the partnership will make best effort to pay out enough to cover taxed amount.

6. Raising addition capital o The partnership can bring in new partners who have to buy their way into the

partnershipo Law firms will normally garner partnership allocations until the new partners

amount to buy in is paid offo Borrow $$ (usually through a revolving line of credit)

Martin v. PeytonPg. 32, CB*Demonstrates the efforts some parties make to distinguish themselves from a partner to a lender to avoid joint & several liabilityFacts:

Π: Martin/ Δ: Peyton (lenders) K&K owed Martin $ but they couldn’t pay so Π argues that Δ is a partner in K&K

so they are jointly and severally liable for Peyton’s debt

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Peyton loaned $500k to Hall Hall offered partnership to K&K but they declined K&K loaned $2 mil of liquid securities (investments that can quickly and easily be

converted into cash – like government bonds) In return, Δ was to receive 40% of profits until loan was paid off and the option to

become a partnerIssue:

Did Δ intend to become partners in the business when they gave the loan?Law:

UPA 6(1): definition of partnership UPA 7(4): share of profits are prima facie evidence of partnership HOWEVER

UPA 7(4)(d) states that if profits are for payment of loan then the inference cannot be made (also in RUPA 202 (c) (3) (v))

Holding: Δ was not a partner in the partnership so not liable for debt Presumption is if one receives profits they are a partner, unless, the profits are

being paid as repayment for a loan (UPA §7 and RUPA §202)

Lupien v. MalsbendenPg. 36, CB*Control v. Co-Ownership**Co-owner does not mean joint title to assets; rather, it is the right to make decisions/controlFacts:

Π purchased “kit car” by VW from Cragin but never received it Cragin fled the country leaving only Malsbended as a Δ so Π claimed that Cragin

and Malsbended were partners thus making them joint and severally liable Δ claims that he was only a lender and not a partner Π claims Δ was a partner b/c his loan was interest free, he had a say in decision

making of business, he wrote checks from his personal account for the business, and w/out Cragin present Malsbenden was in control

Issue: Does co-owner/partner mean jointly owned assets or right to control?

Holding: Right to control is essence of co-ownership. Rights to assets and title of parties

is dispositive (footnote 4, pg. 37)Notes:

Difference between Lupien and Martin is control In Lupien – Δ exerted control over business decisions that was consistent with that

of a partner In Martin – Δ’s control was typical control that any lender would assert

Summers v. DooleyPg. 43, CBFacts:

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Π and Δ own trash collection business together Π hired a 3rd person to work but Δ refused so Π paid for 3rd party out of his own

pocket Π claims that Δ was unjustly enriched by the 3rd man so he should be required to

payIssue:

Whether an equal partner in a 2 man partnership has the authority to hire a new employee in disregard of the objection of the other partner and the attempt to charge the dissenting partner with the costs incurred as a result of his unilateral action

Law: ID default provision: any difference arising from ordinary matters may be decided

by majority of partners UPA 18(h): in the absence of an agreement regarding decision making power,

majority regardless of partnership percentage (look at control %)Holding:

In a 2 person partnership both must consent as both have equal veto power when their control is 50/50

Δ objected to hiring so he is not bound to pay

HypotheticalPg. 46

A, B, and C enter into a partnership.A – 90% of capital and 90% of profits or allocation of lossesB – 5% of capital and 5% of profits or allocation of lossesC – 5% of capital and 5% of profits or allocation of lossesIn a dispute A votes one way and B/C vote another. B/C win b/c 2 out of 3 is majorityRUPA 301(f): partners have equal stay unless partnership agreement states otherwise

Sanchez v. SaylorPg. 44, CB

Facts: Π and Δ were equal partners w/out partnership agreement They applied for a loan for the business but Δ refused to submit her personal

financial records so they lost the loan Π brings suit against Δ claiming he breached his fiduciary obligations

Holding: All partners have equal rights in management and conduct of business of the

partnership. Δ was legally invested with an equal voice in the management of the partnership affairs and neither partner had the right to impose his will or decision concerning the operation of the partnership business upon the other

Law: ID default provision: absent an enforceable agreement covering such circumstances

of disagreement, when both partners in a two-partner partnership disagree on

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advantageous prospective business transaction, it is dissolution, not an action for breach of fiduciary duty, that is the appropriate avenue of relief

Meinhard v. SalmonPg. 71, CBFacts:

Lease for property on 42nd and 5th.Holding:

Gerry excluded his coadventurer from any chance to compete, from any chance to enjoy the opportunity for benefit by virtue of his agency. He was under a duty to concede

Law: Joint adventurers, like copartners, owe to one another, while the law enterprise

continues, the duty of the finest loyalty. Pursuing an opportunity for self-gratification breaches that duty RUPA 403 and 404(b)(i)

UPA 103(b)(3): the partnership agreement can define what a fiduciary duty means, but CANNOT eliminate the fiduciary duty entirely

Note on Joint Ventures (JV): Formed for a single transaction/ sole purpose. o Thin line between joint ventures and partnershipso General rule is that JV’s are governed by partnership lawo UPA 18(a) and RUPA 202

3) Limited Partnership (LP) Has 1 or more general partners and 1 or more limited partners Limited partners have limited liability but in return do not have control or

management Old ULPA 201: requires statutory filing of certificate of limited partnership

with the sec. of state Limited partners have limited liability not joint and several so public must be put

on notice Exactly the same as general partnership with the exception of Liability and

Control/Management

1. Liability o General partners have joint and several liability but in return they get to

control and make decisionso Limited partners invest (like silent partners) and enjoy limited liability. In

return, they lose control in management

2. Control/ management o General partners have joint and several liability but in return they get to

control and make decisionso Limited partners invest (like silent partners) and enjoy limited liability. In

return, they lose control in management

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o EXCEPTION: if LP gets too engaged in business then becomes GP and assumes joint and several liability

o Control rule: if you want limited liability you must give up control (new ULPA 303: abolishes control rule in order to make LP more competitive with LLC.

3. Transferability of ownership interest : same as GP – only financial interest4. Continuity of existence: same as GP – until a specified event5. Taxation: same as GP – flow-through tax entity6. Raising addition capital: same as GP – borrow or add more partners

Notes from class 5.29.08 Nagging problem of LP is that at least one person has j&s liability which is not

user/investor friendly To avoid make LP a corporation – interpose LL between person and corporation –

The LP can form a corporation to act as the GP that makes all the managerial decisions (BOD – sole owner) and controls what the LP does and are indirectly in control. This reduces/ eliminates j & s liability of investors if LP has a loss. Law suits will be brought against corp. b/c they have j&s liability and once it pays out all that it can that is it and investors are not subject to j&s liability

Gateway Potato Sales v. GB InvestmentsPg. 468, CBFacts:

Gateway sued limited partner rather than general partner b/c they had deeper pockets

Sunworthy Packing (LP) defaulted to creditors (Gateway) so Π argues that GB crossed line from LP to GP b/c they managed and acted like GP

(activities described on 469/70)Holding:

Liability for an LP whenever the LP exercised substantially the same control as GP, even though the creditor had no contact w/ LP and no knowledge of LP’s control

Law: AZ statute 1st sentence (same as old ULPA 303(a)): LP can go too far. If they act

like a GP they are jointly and severally liable. 2nd sentence waters it down (same as old ULPA 303(b)): however, if the LP’s

participation in the control of the business is not substantially the same as the exercise of the powers of a general partner, he is liable only to persons who transact business with the LP w/ actual knowledge of his participation in control.

Clandestine problem : if you act like a GP, even in secret, you are on the hook but only to people w/ actual knowledge (the 2nd sentence completely eliminates this problem)

Indirect knowledge problem : based upon LP’s conduct, the only requirement is that the creditor had actual knowledge of the LP’s participation in control. 2nd sentence does not help

Takeaway:*Control rule – LP acting like GP deemed have j&s liability regardless of their title

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**Control rule has been watered down by new UPA – exceptions of LP actions that will still not let them lose their limited liability

In re: USAcafesPg. 476, CBHolding:

Directors of the GP owed the LPs no duty of loyalty or care, but owed the GP and shareholders duty of loyalty.

Fiduciary duty – one who controls property of another may not, w/o implied or express agreement, intentionally use that property in a way that benefits the holder of the control to the detriment of the property or its beneficial owner.

Human being still owes fiduciary duties to partners (Cardozo called “duty of finest loyalty”)

4) Limited Liability Partnership (LLP) LLP is essentially a GP formed under a statute by professionals LLPs use this status to limit malpractice All partners are j&s liable for all general obligations (same as GP) In respect to malpractice, each partner only liable for his own personal acts of

malpractice – no vicarious liability for torts, K, or otherwise This is the allure of LLP – pro-professional and anti-client This is why LLP’s are required to maintain malpractice insurance so to put

prospective clients on notice also why they must register with sec. of state RUPA 101(5): limited liability partnership: means a partnership that has filed a

statement of qualification under 1001 and does not have a similar statement in another jurisdiction.

RUPA 1001 : any partnership may become a limited liability partnership by filing a statement of qualification

RUPA 1002: LLP must be in name or title

5) Limited Liability Company (LLC) Creatures of statutes – articles of organization filed w/ sec. of state 70% of the time – LLC is the best way for a new business to go Designed to take best of partnership form and best of corporate form RULLCA 201: must file articles of organization w/ sec. of state RULLCA 104: an LLC is an entity distinct from its members and has perpetual

duration RULLCA 108: must contain LLC in title Can have a 1 member LLC No requirement to be a partnership first then convert to LLC Members

1. Liability

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o Like a corporation, all owners have limited liability (only lose investment) which is a plus from the owner’s perspective

o Member: owner of LLC. Statutory requirement to put people on notice of limited liability. In NY, requires filing of article of organization with sec. of state but then they must place ad in paper and if that paper is NYT then its really expensive. No need to actually file (per Haas)

2. Control/ management o Like a partnership, incredibility flexibleo All member by default have equal control unless otherwise stated in operating

agreement (much like a partnership agreement) – same topics o Operating agreement can place control in hands of only a few members

(manager-managed LLC) or all can have equal control (member-managed LLC) (RULLCA 102)

o Is your LLC member managed or Manager managed? – operating agreement will say – depending on the number of owners, it will tell who is managing

3. Transferability of ownership interest o Essential same as a partnership – governed by operating agreemento Default rule allows transfer but only financial attributes.o Transferee always maintains limited liability by statuteo Not until other managers approve can a new member receive managerial

control does liability lay with awaiting member o NO J & S liabilityo Voting structure decided in operating agreement – if you want to limit

transferability then require unanimous vote

4. Continuity of existence o Essential same as a partnership – when certain events occur specified in

operating agreement or as specified in statute – members decide to keep LLC or they can agree on dissociation (like dissolution)

o RULLCA 102(c): an LLC has perpetual duration

5. Taxation o Flow-through tax entityo No income tax, it sends its members a scheduled K-1 that allocates to member

profits, losses, shares, etc.o Line 17 of W-10

6. Raising addition capital o Essential same as a partnership – additional managers allowed in contingent

upon operating agreement (differs from S Corp. in this way)o Extremely flexible b/c manager can have many different ownership rights

– different classes of ownership interesto Whatever people want to agree to

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6) Corporation Creature of statute - must be granted corporate charter by state of incorporation States have general incorporation laws – state generally today, used to have to go

to state legislature and then granted to do a particular job States passed general incorporation laws – no longer necessary to ask legislature Separate and distinct legal entities – artificial person in the eyes of the law –

from those who own and manage them Publicly-traded must register w/ SEC Shareholders: are owners Managers: are Board of Directors (shareholders elect) – more of a watchdog Officers: carry out day-to-day decisions (CEO, CFO (controller), President, GC)

RULLCA 102) Officers can carry more than one title Officers can be manager (director) Large corporations bifurcate the CEO from the Chairman of the Board BOD selects the officers or least approves them Officers select the lower managers (senior executives)

1. Liability o Owners (shareholders) have limited liability (quintessential example of LL) –

not liable personally, but can lose investment as shareholdero Can lose this by Piercing the corporate veil

o Owners have power to enter into K, power to be sued, power to bring suit, ability to commit crime, ability to subject to income taxes

o Corporations have constitutional rights (Due Process Clause and equal protection, attorney-client privileged, protected from illegal searches and seizures, can sue for defamation, expansive 1st amendment rights)

o Corporations CANNOT plead the 5th and do not have right to privacyo NYBCL 630: 10 largest shareholders have j&s liability for all debts

2. Control/ management o Direct management is removed from shareholders separation of ownership

and control agency cost – cost of management separated o NYBCL 701 & DGCL 141(a): control of corp. resides in hands of BOD in

publicly traded corps (in a closed-corp. the owners are managers, shareholders, officers, etc.)

3. Transferability of ownership interest o As general matter, shares are freely transferableo Privately held corps have more restrictions like the operating agreement of

LLC, in the shareholder’s agreemento Fed and state securities law govern the transferability

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Publicly Traded Private/ Closely Held1. Capital Raising Trade on a publicly traded

market (i.e. NASDAQ)In order to go public, corp must register, file disclosure document, and have IPO (initial public offering)

Sell to a select group of investors

2. Management/ control Separation of owners (shareholders) and controllers (BOD)

Multiple hats

3. Transferability Part of IPO register w/ SEC and list on publicly traded market so very liquid

Not liquid b/c difficult to find someone who wants to buy shares. Plus, agreement usually places restrictions

4. Transparency Must file periodic reports that are publicly available (10K, 10Q, O, 8K)

Information is proprietary/ confidential. Only available when applying for loan or interacting w/ financial institution.

4. Continuity of existence o Corp has perpetual existence by default o No dissociation or dissolutiono An expiration can be placed in corporate charter but this is rarely done

5. Taxation o Sub C: Entity level tax and shareholder’s taxed = double-taxationo Sub S: treated as flow-through tax entity (no entity level tax). Taxed pro rata

(based on # of shares)o Sub S qualifications:

No more than 100 shareholders Shareholder must be a natural person (or qualified estate/ trust) or

another Sub S corp Must be U.S. citizen or resident alien Corp can only issue one class of stock Have 90 days from filing charter to file for Sub S

o Restrictions: S corp may buy stock in and C corp but cannot be owned by any C corp.

o Policy reasoning for S: to help small businesses b/c they generate job growth and we do not wan tot deter small businesses to become corporations and still benefit from flow-through taxation – that is why # of stockholders and domicile is important

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o Problem w/ S: WY introduced LLC which is way more appealing. Most S corps grow into C

6. Raising addition capital “C” can flexibly raise capital through debt securities or issuance of stock (preferred or common). They are K claimants, not ownership claimants. Capped interest rate, priority in the event of liquidation.

a. Securities: o Bonds: long-term, secured, collateralized.o Debentures: long-term IOUs, not collateralized. Naked promise to repay.o Notes: short-term IOUs, secured or unsecured.o Trade debt (accounts payable) – amounts that a corporation owes for goods

and services at any point in time.o Bank debt (loans payable) – financing from commercial-bank loans.

b. Preferred stock : *Dividend preference: until the current stock dividend to preferred stockholders are paid up, you cannot pay dividends to common shareholders. *Liquidation preference: once all the creditors are paid in full, the preferred shareholders are paid second according to the stated dollar amount in the K.

i. Difference between debt and preferred stock – debt holders have a fixed claim on the corporation for interest and principal while preferred shareholders normally have no fixed claim for distributions.

c. Common: common shareholders get everything else after the creditors and preferred stockholders are paid off. Normally, common stock carries the right to vote in the election of directors and certain other matters.

Hierarchy of Repayment – “Food Chain”1. Creditors

Secured creditors - those who have secured collateral (i.e. land) Senior creditors Subrogated creditors – lowest on the food chain b/c they demand higher interest

rate Subordinated – if you agree to be here, you get a higher rate of interest (“junk

bonds”)2. Preferred Stockholders

Liquidated preference + any accrued/ unpaid dividends3. Common Stockholders

They get whatever is left

Delaware is popular b/c:1) Statutorily liberal: minimal restrictions on managerial control which aids in

agency costs (i.e. 1st state to adopt take-over defenses like “poison pill”) The DGCL minimizes shareholder ability to vote which gives managers more power

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2) Higher level of predictability: case law precedent covers almost every case that can come up b/c so many corporate decisions decided under DE law

3) Efficient judiciary: DE Chancery Court quick to hear and decide cases. Also, allows lawyers admitted to any state’s bar to issue a corporate law opinion – incentive for out of state corps to incorporate there

Problem #1Pg. 2, SCM

Facts: Harman – part owner w/ daughter of box manufacturing company which is on

decline Roberta – daughter who wants to expand business Lindsey – box designer w/ no $ but will contribute time and skills and would

receive “sweat equity” in return JP Smith – investor (capital provider) Business current value = $200k (book value) Book Value equals total assets minus total liabilities [BV= TA – TL] Smith is investing $75k Lindsey is investing services The terms are to “share and share alike”

Analysis of 6 factors to determine best form of business for Harman1. Liability: He’s contributing real $ so liability is important. An LP, LLP, LLP, or

corp. would work. If corp. formed in NY he would have j&s liability b/c of NYBCL 630 which holds the top 10 shareholders liable so this would be out. Limited liability in small business is not favored by creditors so they will usually require personal guarantee from shareholders

2. Control/ management: He cares about control as he devoted his whole life to this company. Would want LLC, corp. LLP, but not LP b/c he wants control. JP Smith would want LP if he is limited partner.

3. Transferability : He is closest to death so he wants someone to be able to inherit his interest and control (continuity not that big) so GP, LP, or LLP and handle it in partnership agreement

4. Continuity: not that big of a deal5. Taxation: He would want flow-through so S corp would be good b/c flow-

through taxation and flexibility in raising capital6. Capital: not an overriding concern for him so LLC or C corp would be easiest

way to raise capital**LLC would be best

Analysis of 6 factors to determine best form of business for RobertaRaising additional capital would be an overriding concern for her b/c she wants to grow this business so LLC would be good b/c of flexible capital structure. C corp. would work but would be subject to double tax. S corp. is out of the question b/c limited flexibility to raise additional capital

**LLC or C corp. would be best

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Analysis of 6 factors to determine best form of business for Lindsay1. Liability: she has no liability but she has not assets to lose so GP wouldn’t hurt

her unless business started becoming extremely profitable2. Control/ management: she would want control b/c these are her ideas being

implemented so this is her most important factor. An LP could work b/c UPA/ RUPA allows employees

3. Transferability : She is just starting out so this is not a concern to her now, however, if the business takes off this will be of interest to her

4. Continuity: she wants the business to go on long enough for her ideas to take off5. Taxation: she can be screwed two ways here: 1) if they reinvest profits instead of

distributing them and she gets taxed w/out an allocation and this is her only source of income then she has no way to pay taxed amt; and 2) if there is a loss and she has not other income to offset then it won’t help her at all.

6. Capital: this is just as important to her as the other players b/c this company needs to take off. We would need to point this out to her b/c she may not realize it.

**Almost any form, except S, would work for her. S corp does not allow flexibility to raise additional capital. She is only one that can go with almost all forms.

Analysis of 6 factors to determine best form of business for JS Smith1. Liability: He wants a LL b/c he doesn’t want to lose more then his investment if

something goes wrong his personal assets aren’t exposed 2. Control/ management: he is a silent investor and putting his trust in them to run

this business so LP would work for him if he were a limited partner3. Transferability and Continuity: he does not want to be locked in forever b/c he

wants either a large company to buy or find an investment bank to take this public. He needs an exit strategy so transferability very important

4. Taxation: because he has other investments this would be advantageous to him both ways. If they meek $ then gets an allocation of profit. If loses $ he can use the loss to offset profits he made elsewhere.

5. Capital: he wants other potential buyers to come in and he wants it to grow so he wants flexibility here too.

**LP as a limited partner would be best for him. Corp could work as long as it goes public later. LLC works too

Recommendations for group: 1) Manager-managed LLC w/ operating agreement all but JS Smith as a manager; 2) S corp to get flow-through tax until they grow enough to change into C corp (becoming C corp would be good sign of growth); 3) LLC would be good b/c you can have more than 100 shareholders and foreign shareholders and if investment bank comes in to take it public then they can file corp. charter.

Corporate form: you can make S election but Smith and Mr. Harman would prefer it b/c older generations are afraid of LLC’sConcerns:

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Corp is high maintenance b/c of statutory housekeeping (board meetings, formal notice of meetings) which is costly especially b/c lawyers need to do this and so it’s an ongoing legal expense.

Partnerships and LLC have less restrictive corporate governance Corporations are required to distribute profits on pro rata basis (proportionate to

# of shares) An LLC can always convert to corp. later

Haas questions 6.3.081. In which state should a new corporation incorporate?

Closely-held : should incorporate in the state they are doing business b/c do not want to pay extra taxes (taxed in state doing business and where they are incorporated). DE laws do not benefit smaller corps

2. What if incorporated in NY then decide to go public – can a company change the state of incorporation right before going public?

Yes, the process is called reincorporating NY corp can form a new subsidiary corporation called a drop-down, incorporated

in DE then merge the 2. The NY corp. becomes obsolete with all assets and liabilities automatically belonging to DE corp.

Class #3: Capital Structure

Capital: the amount in the company’s stock account. Funds, cash, property – assets contributed to business in return for stock that business uses to make $.

Legal capital: amount of capital that stockholders contribute to the company that, by statute, must remain permanently in the company to satisfy the claims of creditors.

Legal capital rule: a corp must always maintain a minimum capital cushion on right side of balance sheet which is offset by left side of balance sheet. It is a compromise between creditors and common/preferred stockholders. Passed to ensure that dividends/ distributions not paid to shareholders to detriment of creditors.

DE Legal Capital Rule based on par value

Par value: legally allowable, minimum amount of consideration that an investor must pay by law for common or preferred stock (the floor price).

When it’s available for creditors, it’s off limits to shareholders Protects creditors – maximize the capital cushion by raising the par value BOD determines the p.v. in the corporate charter. They can pick any amount they

want. BOD cares more about stockholders than creditors so lower p.v. = smaller capital cushion, hurts creditors. Higher p.v. = larger capital cushion

Common shares are issued for a price higher than the par value

Par value and # of shares to be issued located on balance sheet, certificate of incorporation, corporate charter, stock certificate, financial statement

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No par value stock: BOD can state $ amount at time they issue stock so they leave amount blank until they do this. It is an ad hoc determination. If they aren’t decided then it goes into CSA which is beneficial to creditorsDGCL 151(a)NYBCL 501(a)

Watered stock: stock which was issued w/out corresponding pay-in assets valued @ an amount lower than what other stockholders paid yet they still have equal ownership rights. Not fully paid and assessable – corp and creditors can come after holder to get $ owed

Legal issued water stock: paid lower than p.v. for shares so those shares are not fully paid and not non-assessable so company can come after you or if company is no longer in existence then creditors can come after you.NYBCL 504(c)DGCL 153(a)

Capital structure (capitalization): where did funds, assets come from?Equity contribution: property in exchange for shares/ownership, loans expected to be repaid

Balance sheet: Financial statement that provides capital structure information. Assets: inventory, balance in accounts, property, IP (left side of balance sheet) Liabilities: what is owed to 3rd parties by bank/ trade debt, debt securities (right

side of balance sheet) Owner’s equity: shareholder’s equity (corp.) partner’s equity (GP, LLP) (right

side of balance sheet)**Left and right side must always balance = (TA-TL) - capital

Assets Liabilities

1. Current Assets (CA) 1. Short Term (ST)2. Fixed Assets (FA) (PPE) 2. Long Term (LT)3. Intangible Assets (IA)4. Other Accounts (OA)

Owners’ Equity

Capital ContributionShareholders’ Equity:

CSA = # of o/s shs of c/s x p.v./ shs

PSA = # of o/s shs of p/s x p.v./ shs

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APIC

Retained Earnings or Deficit (RE/D)

Total Assets = Total Liabilities + Owners Equity

Left side:*In order of liquidity1. Current Assets: turned into cash easily (i.e. securities, inventory)

2. Fixed Assets: tangible assets used in operations of business but not easily turned into cash and used in day-to-day business.

PPE (property, plant, equipment): value of PPE depreciates over time and has to be deducted on balance sheet. Depreciation charge flows into income statement.

Appreciation of land does not show up on balance sheet

3. Intangible Assets: IP (trademarks, patents)

4. Other Assets: pre-paid expenses (i.e. if you pay for full year rent then the other 11 months are considered pre-paid expenses)

Right Side:Liabilities: Borrowed money that has to be repaid. Amounts and due dates are predetermined.

1. Short-term debt./ current liabilities: due within the next year or sooner (i.e. current portion due of long-term bond, accounts payable, bills)

2. Long-term debt: things due in later than a year

Creditors – Contract Claimants Indenture is the contract for bonds and debentures. Indenture trustee: the bond holder. Not in privity of K. They are 3rd party

beneficiaries of K. If publicly traded then they must comply w/ SEC (i.e. Trust Indenture Act of 1939

which governs the relationship of trustee to the issuer)

Shareholder’s Equity

Capital: what shareholders contribute in exchange for their equity (common stock CSA and preferred stock PSA)

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Retained earnings or deficit: What portion is being retained and not paid out**loss suffered is reflected here= cumulative earnings – cumulative earnings distributed to owners of dividends

Other comprehensive income or loss: if business generates gains/ losses not continuing business profits/losses

CSA (common stock account): equals the number of outstanding shares of common stock, multiplied by par value per share of common stock

CSA = # of o/s sh of c/s x p.v./ sh DGCL 4 capital NYBCL 506 stated capital

PSA (preferred stock account): equals the number of outstanding shares of preferred stock, multiplied by par value per share of common stock

PSA = # of o/s sh of p/s x p.v./ sh DGCL 154 capital NYBCL 506 stated capital

APIC (additional paid-in capital)/ overage: amount s/h pay that is over and beyond par value (aka capital surplus account)APIC= amount paid over par value x #of o/s

RE/D (retained earnings): the profits and losses of the business since inception. Money not given back to shareholders can be reinvested in the business. A corporation’s accumulated income after dividends have been distributed

Ex. 1 c/s 50 shares @ $100 eachp.v. = $5p/s 10 shares of Series A @ $20 eachp.v = $20

Assets LiabilitiesCash Stockholder Equity

$5000 (50 sh x $100) CSA = $250 (50 sh x $5 pv)$200 (10 sh x $20) PSA = $200 (10 sh x $20 pv)

APIC = $4750 [50 sh x ($100 - $5)]

$5200 $5200

DE Legal Capital Rule: Directors may declare and pay dividends upon the shares of its capital stock (CSA or PSA) either (1) out of the company’s surplus or (2) if there is no surplus, out of the company’s net profits for the current fiscal year and/or the preceding fiscal year (very friendly to shareholders)

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Even if no surplus, no APIC, RE/D – can still pay dividend if company had profits last fiscal year. This comes from amount reflected in CSA & PSA (the capital cushion)

DE very friendly to shareholders and BOD Less friendly to common shareholders Less friendly to preferred shareholders Not at all friendly to creditors (backwards from the payment hierarchy)

DGCL 170(a)

Formula: S = (TA – TL) – capitalS = surplus (excess, if any, of company’s net assets over the amount determined to be capital)TA = Left side of balance sheetTL = net assets – amount by which company’s TA exceeds its total liabilities (upper right side of balance sheet)

Ex. #1Pg. 335, Nutshell

c/s = 100,000 o/s sh p.v. = $2 p/shTA = $3milCSA = $200,000 (100,000 sh x $2 p.v)TL = $2.6 milNet earnings = ($400,000)Net earning preceding year = $100,000

S = (TA – TL) – capital = ($3 mil - $2.6 mil) - $200,000 = $200,000 surplus*so can pay aggregate dividend of $200,000** so $2 p/s ($200,000 / 100,000 sh)

Ex. #2Pg. 335, Nutshell

c/s = 100,000 o/s sh p.v. = $2 p/shTA = $3milCSA = $200,000 (100,000 sh x $2 p.v)TL = $2.9 milNet earnings = ($400,000)Net earning preceding year = $100,000

S = (TA – TL) – capital = ($3 mil - $2.9 mil) - $200,000

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= ($100,000) loss this year but last year profit of $200,000*so can pay aggregate dividend of $100,000** so $1 p/s ($100,000 / 100,000 sh)

**The net profit test is an and/or test**

What if director of DE corp declared dividend that violated legal capital rule:DGCL 174(a): directors generally are j&s liable for approving a dividend that illegally reduces the corporation’s capital cushion. They are liable to the corporation or, if the corporation is in dissolution, the corporation’s creditors for the amount by which the aggregate dividend paid exceeds the amount legally available for the payment of dividends.Exceptions:DGCL 174(a) only directors that willfully or negligently violate the legal capital rule are liable. 172 allows directors to rely on the determinations of the corporation’s accountants when deciding whether the legal capital rule is met.DGCL 174(c) any director held liable can, in turn, sue any stockholder who took the dividend with knowledge that it was illegal.

NY Legal Capital Rule: 2 part test and both parts have to be satisfied.1. Equity Insolvency Test: cannot pay dividends to stockholders if it is insolvent or if paying dividends would render is insolvent.

Insolvent : unable to pay its debts as they become due in the ordinary course of business NYBCL 102(8)

2. Net Assets Test/ Balance Sheet Test: restricts distributions to the amount by which corps assets exceeds the sum of its liabilities and “stated capital” NYBCL 510(b) TA – TL > stated capital “stated capital” amount set forth in the capital stock account on the balance sheet

Same as DE Capital = CSA + PSA In NY, max dividend allowed = (TA – TL) – stated capital so same as 1st prong of

DE surplus formula But remember in NY, must satisfy BOTH tests – you do not get to look at

previous year profits or current year profits

Ex. 1c/s = 500,000 o/s sh p.v. = $1 p/sTA = $5.1 milCSA = $500,000 TL = $3.2 milNet earnings = ($400,000)Net earning preceding year = $100,000

1. Solvency Test: assume it is solvent $5.1 – $3.2 so liquidated amount is $1.9 mil

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or you can say CA v. CL (common asset exceed current liability)$1.9 > $500,000 so solvent

then

2. Net Asset Test: TA – TL > SC (stated capital)$5.1 mil – $3.2 mil > $500,000So max dividend payable = $1.9mil - $500,000 = $1.4 mil aggregate (1.4/ 500k sh/ o/s) = $2.80/ sh

Ex. 2c/s = 500,000 o/s sh p.v. = $1 p/sTA = $3.6 milCSA = $500,000 TL = $3.2 milNet earnings = ($400,000)Net earning preceding year = $100,000

1. Solvency Test: assume it is solvent $3.6 – $3.2 so liquidated amount is $400,000or you can say CA v. CL (common asset exceed current liability)$400,000 > $500,000 so insolvent – no dividend

Then Don’t even do the Net Asset Test once the Solvency Test Fails

NYBCL 719 (a)(i) and (d)(i) Liability for NY director is essentially the same as DE

Valid consideration for stockBoth NY and DE allow future services as valid consideration for stockNYBCL 504(a)DGCL 152

PREFERRED STOCK

Preferred stock: a hybrid security featuring characteristics of both debt and equity. Debt-like characteristics: high par value (like the face value of a bond), regular

defined dividends (like interest payments), ranking “senior” to CS holders PS dividends are payable at the discretion of the BOD. This is distinguishable

from debt in that a company with debt outstanding must make interest payments “come hell or high water”

Equity-like characteristics: dividends payable at discretion of BOD and subject to legal capital rules, limited fiduciary duties, “junior” ranking to creditors during liquidation

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PS holders are contractual claimants (like creditors) – rights are delineated by K (the corporate charter). Certificate of amendment/ designation filed w/ sec. of state to determine the amount and attributes of that specific series of stock

Privileges associated w/ series of stock may vary b/c the attributes of each series are heavily dependant based on the market conditions @ the time issued

The charter can specify that amount will be determined at a later time via a charter amendment or black check preferred stock provision

Blank check preferred stock provision: this provision grants the BOD the authority to issue a new series of PS when the board believes doing so is desirable. The CSholders will have had to approve a charted amendment allowing this. DGCL 102(a)(4) and NYBCL 402 (a)(6)

Certificate of designation: resolution that is filed to add preferred stock. DGCL 151(g) and NYBCL 502 (c) and (d)

1. Dividend preference: in the event dividends are paid, PS holders have priority over CS holders (dividends are payable at discretion of BOD and must satisfy legal capital rules first) DGCL 151(c)

Annual dividend rate is stated as a fixed % of p.v. or as fixed annual dollar amount (i.e. 10% Series A or $2 p/sh)

Usually higher amount than debt security interest rate b/c its riskier

Cumulative and Noncumulative Preferred Stock1. Cumulative: if the board chooses not to pay a dividend (does not want to or legal capital rules not satisfied), it becomes an arrearage (missed preferred stock dividends that have accumulated), and the board must pay the cumulative preferred stockholders’ arrearage and current quarterly dividends before common stockholders.

Like rollover minutes Most are this type If BOD chooses not to pay cumulative preferred stock dividends for 6 consecutive

months then shareholders can elect 2 BOD members

2. Non-cumulative: if they pass on paying the quarterly stock dividend, that dividend is gone forever, even if there is money later and the board wants to pay.

Why would someone want non-cumulative stock? Venture capitalists will buy this kind of preferred stock b/c of its liquidation preference, has value in the context of a young company.

Noncumulative convertible preferred stock provides venture capitalists with the downside protection of preferred stock and the upside potential of common stock

2. Liquidation preference: in the event of any voluntary or involuntary liquidation, dissolution, or winding up of the company, the company must pay preferred stockholders their stated (i.e. contractual) liquidation preference prior to the distributing any assets to common stock holders. Dollar amount in charter, typically the par value, until preferred shareholders are paid their dividends then common stock holders get nothing.

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In the event that the company has insufficient funds to pay the preferred stockholders their full liquidation preference, then the company will divide its available assets among them on a pro rata basis.

Preferred stock contract: will specify whether a given series of preferred stock is cumulative or noncumulative and will address the following negotiations between the company and prospective preferred stockholders (or their agent).

Preferred stock is a negotiated security: negotiated with investors or investment bank

Statutory voting rights: right of preferred and common stockholders, vote together as a single class, in order to approve an amendment to corporate charter DGCL 242(b)(1) and NYBCL 803(a)

o If the proposed amendment would affect or change, in an adverse way, the powers, preferences, or other special rights of a series of preferred stock, the holders of that series are entitled to vote as a separate class DGCL 242(b)(2) and NYBCL 804(a)

Contractual voting rights: the preferred stock contract typically provides preferred stockholders with the right to elect a specified number of members (typically 2) to the company’s BOD if company misses a specified number of quarterly dividends (usually 6)

Conversion rights: Preferred stock contract may grant conversion rights to preferred stockholders. Those rights allow them to convert their shares of p.s. into shares of the company’s common stock at a specified conversion price. Has the downside protection of preferred stock and the upside potential of common stock.

Participation rights: These rights entitle p.s. holders to receive, in addition to their p.s. dividends, dividends payable on common stock as if each share of preferred stock they held were a share of common stock.

Redemption rights: Company can redeem some or all of the outstanding shares of a given series of p.s. Would want to do this if interest rate drops. Negotiated by company b/c it benefits company.

COMMON STOCK

Common stockholders: are equity owners (true owners). CS holders are residual claimants – they are residual in nature b/c creditors and preferred stockholders are in line before them

In a liquidation context, they are entitled to any assets of the corporation that remain after the corporation liquidates and pays creditors and preferred stock holders

Voting: CS holders elect BOD and vote on many fundamental corporate transactions (i.e.

mergers, dissolution, amendments to charter)

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Usually one vote per share. Can also issue non-voting shares but must also have voting stock or else who would elect BOD? DGCL 212(a) and NYBCL 501(a)

If corp issues non-voting stock the public stock exchanges don’t list it so a company can create super-voting stock (i.e. 10 votes per share) then sell a different class w/ only 1 vote per share

The only difference between Class A, Class B, etc. is the voting rights. The amount and dividend payout is the same across the board.

Dividends: Dividends are payable at the discretion of the BOD Subject to Legal Capital Rule Corp can pay dividend in cash or can distribute property, other securities, stock

dividends (or even whisky – Whiskey Dividend Case) Stock dividends consist of debentures and spin-off (a corporate divestiture in

which a division of a corporation becomes an independent company and stock of the new company is distributed to the corporation's shareholders) DGCL 173/212(a) and NYBCL 510(a)

Voting Dilution and Preemptive Rights: Voting dilution: the reduction in the fractional ownership involved with a given

stockholder’s stock that results from the corp’s issuance of additional shares of common stock and/or the conversion of convertible securities into shares of common stock.

Preemptive rights: stockholder’s right to subscribe to new stock issuance in preference to persons who are not stockholders. The corp must first offer her a fair and reasonable opportunity to purchase the portion of the newly-issued shares necessary to maintain and preserve her current ownership interest in percentage terms. DGCL 102(b)(3) and NYBCL 622: no preemptive rights exist by statute – only if specified in charter

PART B: CORPORATE FORMATION AND LIABILITY ISSUES

Corporate governance is the set of processes, customs, policies, laws and institutions affecting the way a corporation is directed, administered or controlled. Corporate governance also includes the relationships among the many stakeholders involved and the goals for which the corporation is governed. The principal stakeholders are the shareholders, management and the board of directors

o A corporation’s internal affairs are governed by the law of the state of its incorporation even if it does no business in that state (i.e. DE – DGCL; NY NYBCL (variation of Model Act)

Corporate Governance Documents: Certificate of incorporation/ charter By-laws

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BOD resolution: written statement of BOD resolve to take a particular action (contained in minutes of BOD meetings)

**In hierarchal order

Corporate Charter

DGCL 102 and NYBCL 402: what must be in charter

NYBLC 301: Corporate name301(a)(1): must contain corp., incorporated, lmtd., or some variation301(a)(5): list of words that cannot be in name301(a)(2)(ii): must be distinguished from names of domestic limited liability companies (i.e. can’t be IBM Inc.)

NYBCL 402(a)(2): Business purposeState specific or generic business purpose in charter. Usually a corp. will have both “Purpose is to specific purpose and any lawful activity in the state of NY”

NYBCL 402(a)(4): Authorized # of sharesAggregate # of shares which the corp shall have the authority to issue. Must list class w/ or w/out par value

NYBCL 402(a)(5): Share classesIf shares are divided into classes, the designation of each must state rights, preferences, and limitation of the shares of each class.

NYBCL 402 (a)(6): Blank check provisionGrants the BOD the authority to issue a new series of preferred stock when the board believes doing so is desirable.

NYBCL 402(a)(9): DurationCorp is perpetual unless the charter states otherwise. Can be amended to change

NYBCL 402(b): Director’s personal liabilityLimits directors personal liability for breach of certain fiduciary duty (duty of care)Analogous to DGCL 102(b)(7)

NYBCL 402(c): Everything else in charterCorp can add anything to the charter so long as it is legal

Amending Charter: General NY rule: if stock has been issues then BOD and p.s. and c.s shareholders

must approve. If it would adversely effect one of them then they have veto power Once approved then file certificate of amendment NYBCL 803(a) and DGCL 242

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Exceptions: If no shares have been issued, then sole incorporator can file certificate of

amendment and don’t need BOD approval b/c no BOD has been formed NYBCL 803(d) and DGCL 241

Can fix typos w/out BOD approval (but NOT name)

By-laws

By-laws: Mechanics that govern meetings of BOD, shareholder meetings, #of BOD

members, how to fill BOD vacancies Describes titles and description of some positions Shareholders can amend by-laws at any given time. Most charters can allow

directors to amend by-laws w/out shareholder approval. NYBCL 601(a) and DGCL 109(c)

If there is a conflict w/ directors and shareholders in by-laws the shareholders ALWAYS win

Board of Directors Resolutions

BOD Resolutions: Written statement of a BOD’s resolve to take action Often in minutes Rarely a conflict w/ other 2 documents

Class #4Ultra Vires Doctrine

Classic ultra vires doctrine: “beyond the corporation’s power” The corporation is endowed with life and capacity only insofar as provided in its

charter Very narrowly construed Original purpose was to protect the public from unsanctioned activity Ashbury Railway v. Riche: Old English rule. Any K entered into by corp. that

was ultra vires was void, even if corp. amended its charter to encompass those ultra vires activities it contracted to do.

3rd party couldn’t enforce the K; corp couldn’t enforce K

Today’s ultra vires doctrine: NYBCL 202(a) and DGCL 122 Much more broad – gives corporations a litany of implicit powers Certainty of commercial dealings trumps ultra vires Ultra vires acts are acts that go beyond specific corporation’s power – they are

legal acts but this corp does not have power to do. Illegal acts are illegal for everyone. Unauthorized acts are w/in the scope of the corp but not authorized by

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BOD - they are not ultra vires (i.e. K w/out BOD approval – enforceable but corp. can in turn sue the officer that entered into K w/out authorization DGCL 124(2)

Goodman v. Ladd Estate (OR)Pg. 125, CBFacts:

Westover consisted of Liles (sole shareholder), Wheatley (director), and Martin (director)

Wheatley took out a personal loan that was indirectly guaranteed by corp. Wheatley defaulted and Ladd brought suit against Westover on the guarantee but

Westover did not pay Goodman purchased Liles shares of Westover stock and brought action to enjoin

Ladd from enforcing the guarantee on ultra vires grounds Goodman states that Wheatley got benefit from loan, not corp, therefore, the

guarantee was ultra vires (all parties agree that guarantee was ultra vires) Ladd said that Goodman was aware of the guarantee when he bought the shares

and Liles approved itHolding:

Goodman gets no relief b/c they approved it indirectly through LilesReasoning:

If a shareholder has participated in the ultra vires act, he cannot thereafter attack it as ultra vires.

Law: DGCL 124: Ultra Vires Doctrine(1) Ultra vires may be asserted first in a proceeding by the shareholders for an ultra vires act.(2) If the proceeding is due to K, it may set aside the performance of K if equitable.*disconnect between 1 and 2(3) Attorney General can assert ultra vires in an act of dissolution of the corporation or to enjoin unauthorized acts. *policy of protecting public from unsanctioned corporate activity

Dodge v. Ford (MI)Pg. 134, CBFacts:

The Dodge brothers, who held a minority interest in the Ford Motor Co., challenged the decisions by Henry Ford, who held a majority interest, to not issue a special dividend and to employ more men and spread the benefit of the industrial system to the maximum number of people

Ford wanted to make cars better and cheaperIssue:

To what extent may a corporation act in a manner that is not intended to maximize corporate profits?

Holding: Supreme ct. upholds trial court ordering business to pay dividend of $19.2 million

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Reasoning: Courts rarely compel corps to pay special dividends where there was no fraud or

breach of fiduciary duty by the directors This is b/c courts' more general deference to directors' and officers' business

decisions, however, this deference assumes that directors are acting in the shareholders' interest. Here, Ford testified that he was looking out for the interests of employees and car-buyers.

A.P. Smith v. Barlow (NJ)Pg. 137, CB

Facts: Corporation in business of making valves gives $5k to Princeton – approved by

BOD Shareholders argue that it wasn’t in corp charter and bring suit In declaratory judgment action, the lower ct. finds that donation is sound so Δ

appeals Π brings in expert witnesses (CEO’s of other corps and CEO of Princeton) that

testify that donating $ is a sound investment b/c generates good will in community and attracts smarter employees

Δ argues that donation was self-serving for the CEO of corp to get on BOD at Princeton.

NJ statue allows for corporate gifts but statute enacted after corp was incorporated so not grandfathered

Common law: corporations giving charitable gifts is allowed as long as it reasonable amount and benefits the corporation (direct or indirect)

NJ statute: (1) reasonable amount is ok BUT can’t exceed 1% of capital and surplus and must be authorized by shareholders and it cannot violate legal capital rules or negatively impact the capital cushion. (2) donee cannot own more than 10% of stock of corp. giving gift

Notes: This case represents the evolution since Dodge v. Ford of the diminished scrutiny

on corporate gifts Biggest danger of corporate gifts is CEO’s giving to “pet charities” in return for

seats on BOD of gift recipient Both NY and DE allow: NYBCL 202(a)(12): Corporation can add to its charter a

provision not allowing ANY charitable contributions DGCL 122(9): Corporate charitable gifts - does not have NY provision

What is the ability of the BOD to consider constituencies other than the stockholders?NYBCL 717(b): constituency statute; when a Board takes action as to change in control. Can consider employees, customers, creditors, long/short term interests of the corp.

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DGCL: no constituency statute, only case law (Mills Acquisition) as to hostile takeovers. Consider anyone you want, provided they bear some reasonable interest to money for the s/holders.

Pre-Incorporation Transactions by Promoters

Promoter: a person who transforms an idea into a business by bringing together the needed persons and assets, and superintending the various steps required to bring the new business into existence.

Generally they will run company or have equity position once incorporated Promoter often enters into K for the benefit of the corporation before it has been

formed. Liability of promoter (general rule): when a promoter makes a K for the benefit

of a contemplated corporation, he is personally liable on the K and remains liable even after the corporation is formed.o EXCEPTION: if the other party knew that the corp. did not exist yet

nevertheless looks solely at the corp. for performance, then promoter will not be personally liable (Goodman)

o Promoter bears the burden of proof. Preincorporated services constitutes valid consideration for stock NYBCL 504(a)

and DGCL 152

Goodman v. Darden (WS)Pg. 115, CBFacts:

Π in the process of forming corp while entered into K to renovate Δ’s apartment building

Π defaulted and Δ wants to hold him personally liable Π signed K “Building Design & Development Inc (In formation) John Goodman,

President” Checks were payable to corp and Goodman

Issue: Is Π, as a promoter, a party to the K?

Holding: Yes

Law: General rule: when a promoter makes a K for the benefit of a contemplated

corporation, he is personally liable on the K and remains liable even after the corporation is formed.o EXCEPTION: if the other party knew that the corp. did not exist yet

nevertheless looks solely at the corp. for performance, then promoter will not be personally liable

o Promoter bears the burden of proof.Reasoning:

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There was nothing explicit in the agreement that DDS relied on corporation formation when they entered into K so Goodman not off the hook b/c he bears burden of proof and offered nothing that DDS relied on corp. for performance

Once corp. formed, is it bound to K entered by a promoter? A corporation that is formed after a promoter has entered into a K on its behalf is

not bound by the K without more If corporation decides to take over K then must adopt formally or implied

(through performance by accepting benefits from K) Promoter on the hook until novation, unless, 3rd party refuses to let him off hook This is not Ratification: b/c ratification occurs when an unauthorized agent enters

into K on behalf of corp. Here, a pre-incorporated K cannot be ratified b/c ratification requires principal and agent in existence AT THE TIME the K was entered into. There is no principle and agent if has not been incorporated. Restatement 2nd §326.

Agency relationship not present if corp. not yet formed. Only applies to post-incorporated Ks. Ratification is unrelated to promoter liability.

Adoption: agrees to adopt as its own a K that was formed before the corp. was created. You don’t have to adopt a pre-incorporation K. If you don’t adopt, the promoter is left as liable unless the exception applies. Even if K is adopted, promoter and corp are joint and severally liable

Implied adoption is ok: knowingly accepting the benefits and moving forward. Illinois Control v. Langham: a promoter is liable under a K under the law of

promoter’s liability, the fact that the corporation also becomes liable on the K, by adopting it, does not relieve the promoter of liability. Promoter and corp. are joint and severally liable

Novation: completely separate agreement; create a new K to release promoter; corporation is substituted in the K for the promoter. K looks identical to previous K, except the corp. is substituted for the promoter.

This is the only way to get promoter off the hook 3rd parties are often reluctant to sign w/out some form of compensation

Consequences of Defective Incorporation

When, if ever, should a party receive benefit of limited liability when they make an error during the incorporation process?

Depends on whether the corporation exists de jure, de facto, or by estoppel A defective corp does not have limited liability (creditors would argue that

company has joint and several liability) but they can make defenses of de facto or estoppel if they are not a de jure corporation.

De jure: a corporation organized in compliance w/ the requirements of the state of incorporation – a legal corporation

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De facto: insufficient compliance to constitute a de jure corporation so not recognized by state, but steps taken were sufficient for 3rd party to treat enterprise as corporation

Requirements : must execute the certificate of incorporation (must sign), bona fide (good faith) effort to file, must actually exercise corporate power.

If you are found to have a de facto corporation (even if you mess up), the promoter will not be held personally liable for pre-incorporated Ks.

What if everything is done but it’s lost in the mail? Promoter wins if he has exercised corporate power.

What if everything is done but you do not include a fee. No good faith intent and no limited liability.

Cantor v. Sunshine Grocery : exercise of corporate power is interpreted narrowly (you don’t have to show a lot). Lease signing is enough to show corporate power. If you go after the corp. first, that shows that you are looking to them for liability.

In torts, de facto defense is valid

Estoppel: a party who has dealt w/ an enterprise on the basis that it is a corporation is estopped from denying the enterprise’s corporate status. Less of a showing required for estoppel.

Difference from de facto corporation: the estoppel doctrine focuses on the 3rd party’s mental state and actions; de facto corporation focuses on the promoter and what he tried to do.o If you thought of the entity as a corporation and acted as if you dealt with a

corporation you are estopped from arguing that it is not a corporation.o For de facto, all you need is the three elements. You don’t need the 3rd party

at all. Estoppel is a good defense if you can’t prove the de facto corporation defense. The best defense is a de jure corporation defense > de facto > estoppel. State can come after you even if you can prove de facto corporation defense

NYBCL 109(a)(2) and DGCL 329(b) Best way around using a de facto defense and estoppel defense: form a legal

corporation. Best way around pre-incorporation liability for promoters: incorporate first before

you do anything.

Class #5Piercing the Corporate Veil (disregard the corporate entity)

Limited Liability: Shareholder’s are limited to their investment as the only risk of lose if the

corporation fails Shareholders are not liable for corporate obligations by statute Managers are not liable for corporate obligations b/c of principles (i.e. K or

vicarious liability)

Fletcher v. Atex

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2nd circuitPg. 221, CBFacts:

Π: tort claim for injuries suffered by keyboard manufactured by Δ (Apex 805 Middlesex Corp)

Δ: manufactured keyboard and is subsidiary of Kodak (sole shareholder)Issue:

Whether Atex was merely Kodak’s alter ego to constitute piercing the corporate veil

Π: Alter ego theory: Argues that Kodak “dominated and controlled” Atex

DE Law: Under DE law, it is appropriate to pierce the corporate veil when you show fraud,

or when the subsidiary is being treated as the alter-ego or mere instrumentality of the parent company. Here, second applies.

Π has a high burden of proofAlter-ego test: you must show the parent and subsidiary operated as a single economic entity AND that there is an element of injustice or unfairness to the whole situation which would make piercing the corp. veil fair. 1. To show the 2 operate as a single economic entity:

o Make sure there was adequate capitalization o Corporate formalities (were corp. “housekeeping” formalities maintained and

observed).o Siphoning of money – centralized cash management structure.o Alter-ego as a façade of the parent o Insolvency – but this is a given in most cases

2. To show injustice or unfairness: (in this case it wasn’t addressed at all). Conclusory statements are not enough…you need proof!

Reasoning: Adequate capitalization not at issue here b/c that deals with capitalization at time

corp was formed – Kodak bought Atex so not a factor In this case there was insufficient evidence presented by Π to show that Atex did

not follow corporate formalities. On the contrary, Atex presented BOD minutes, tax forms, etc.

No siphoning of $ by Kodak from Atex. Kodak had Atex’s funds for interest maximizing reasons, plus, Atex had full access to the funds at any time

The façade argument was best Π put forward b/c Kodak literature called Atex a division and not a subsidiary. A division is still part of same corporation. Court still held it wasn’t enough to pierce the corporate veil.

Even if Π did raise factual question about domination, they offered no evidence of the 2nd prong

Walkovszky v. Carlton (NY)Pg. 227, CB*NY version of DE law – similar law, different language

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Facts: Π ran over by cab owned by Δ Δ: stockholder of 10 corporations including one that owned cab Essentially a civil procedure case with dicta re: piercing the corporate veil

Issue: Whether these corporations operated as a single entity, unit and enterprise

Holding: Δ did not operate as single entity

Reasoning: “it is quite another to claim that the corporation is a “dummy” for its individual

stockholders who are in reality carrying on the business in their personal capacities for purely personal rather than corporate ends” (same as DE alter ego)

“commingling of funds” (same as DE siphoning of funds)

Avoiding getting your clients corporate veil pierced: Corporate housekeeping necessary for limited liability. Treat the corporation as a

separate and distinct entity; avoid alter ego assertion. (housekeeping is simple and adhering to rules is small price to pay to avoid liability)

Keep your corporate funds away from personal funds, no commingling: transfers of money to you should be documented as a salary or dividend or loan; don’t pay with personal checks.

Provide minimal amount of capital customary for the business involved; substance not just form.

Enterprise TheoryAs scale of business enterprises enlarged, subsidiary corporations became more popular. A single large-scale business is conducted by a constellation of corporations, controlled by a central holding company, the various sectors being separately incorporated. This is because it is better for tax and liability reasons

Minton v. Cavaney (CA)Pg. 239, CBFacts:

Δ ran pool that Π’s daughter drowned in. Seminole was sued and Cavaney was substituted as Δ

Π won $10k but never collected so they argue that Cavaney is Seminole’s alter ego in this new litigation

Δ had no assets except lease for pool. They never issued stock after they were incorporated.

Cavaney – was temporary director, treasurer, secretary (as accommodation to Seminole b/c they were his client and he was their attorney)

CA law, to piece the corp. veil: Director must treat the corporate assets as his own Must add or withdraw capital from the corp. at his will Must hold themselves out as being personally liable for the corp.’s debts

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Must provide inadequate capitalization (“capital was trifling compared with the business to be done and the risks of loss”)

Must adequately participate in the corp.’s affairs (did not use the language “shareholders” b/c Seminole had no shareholders

Policy of adequate capitalization: To protect involuntary creditors (3rd party tort victims)

Holding: Caveney was an equitable owner b/c he was to receive stock if/when stock was

issued for his services as secretary, treasurer, director – it didn’t matter that this was temporary or an accommodation

Notes: Interesting case b/c corp. hadn’t issued any stock and Π argued that Δ was

personally personable b/c of his close relationship with corp. that didn’t respect corporate form but Π can’t go after s/holders if there are none. Plus, he was going to be issued stock in the future

Ct. stated that capital was inadequate when it is “trifling” but 9 out of 10 business fail so the argument can be made that all those businesses had inadequate capitalization (Haas)

Π won but b/c Cavaney was not party to original suit and statue of limitations ran out, Π could not collect

Arnold v. Browne (CA)Pg. 241, CB

Inadequate capitalization alone is not dispositive to pierce corporate veil

Slottow Fidelity (CA)Pg. 241, CB

Inadequate capitalization could be dispositive

Truckweld v. Olson (WA)Pg. 242, CB

There is no law requiring a corporate stockholder to commit additional private funds to an already faltering corporation

Adequate capitalization is only required during corporation formation

Piercing the LLC’s VeilKaycee Land and Livestock v. Flahive (WY)Pg. 499, CB

General rule: veil piercing can happen to LLC Ct said “we can discern no reason, in either law or policy, to treat LLC’s

differently than we treat corporations. If the members and officers of an LLC fail to treat it as a separate entity as contemplated by the statute, they should not enjoy immunity from individual liability for the LLC’s acts that cause damage to third parties”

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WY started the LLC Uses same factors as NY, DE, CA: (1) commingling of funds; (2) inadequate

capitalization; and (3) use of corporation as mere shell (alter ego)**don’t have to show fraud**housekeeping not an issue b/c housekeeping requirements are much less stringent for an LLC than they are for corp.

Equitable Subordination of Shareholder Claims Equitable subordination: allows a court to punish inequitable conduct by reducing the payment priority of an offending creditor to a lesser status than the payment priority of non-offending creditors.

“Deep Rock Doctrine from Taylor v. Standard Applies to controlling stockholder claims as creditors – as a stockholder you can

lend $ which makes you a creditor and shareholder at same time Limited doctrine and only applies to debt claims of controlling shareholders Where do the claims fit? Debt claims go below creditors including liquidation

preference of preferred shareholders pushed down to common stock level Equitable subordination is less drastic than piercing of the corporate veil ES

pushes your claim to the bottom while p.c.v. exposes your personal assets Purpose of the doctrine is to eliminate unfairness or injustice to innocent creditors

in a bankruptcy proceeding Bankruptcy Code §510(c): gives bankruptcy courts the authority to subordinate

claims

Benjamin v. Diamond: factors to consider whether to subordinate a claim: (1) The claimant must have engaged in some inequitable conduct; (2) the misconduct must have resulted in injury to the creditors of the debtor or conferred an unfair advantage on the claimant; and (3) equitable insubordination of the claim must not be inconsistent with the provisions of the Bankruptcy Code (b/c E.S. claims exist inside and outside bankruptcy)

E.S. is not an all or nothing doctrine – if only one claim relates to inequitable conduct then only that one will be subordinated

Limited doctrine and only applies potentially to debt claims controlling stockholders

Pepper v. Litton: where the claim is found to be inequitable, it may be set aside or subordinate to the claims of other creditors

Costello v. FazioPg. 24, SCM**Vivid example of equitable subordination, s/holders in question didn’t engage in fraud but nonetheless the action was inequitable Facts:

Partnership that incorporated and took out capital as a creditor Their initial financial sheet did not look good so they issued promissory notes to

make Fazio and Ambrose creditors (each partner was to receive $2k worth of shares – same as their initial contribution)

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Corporation goes bankrupt 2 years later, complete turnover of creditors – at that time had paid all of their creditors except promissory note payees – if they hadn’t they’d be joint and severally liable

Fazio and Ambrose’s claims were subordinated New capital found to be inadequate

Holding: The corporation was not adequately capitalized at the time of its incorporation

Reasoning: Fazio and Ambrose, serving in a fiduciary relationship to the corporation, acted

for their own benefit when they withdrew capital and it was to the detriment of the corp. and its creditors (and future creditors)

It should have been apparent that the undercapitalization would have lead to business failure

They took advantage of their fiduciary positions hoping to gain equality of treatment w/ general creditors – therefore, their claim should be subordinated

Law: Pepper v. Litton : where the claim is found to be inequitable, it may be set aside

or subordinate to the claims of other creditors Taylor v. Standard Gas : question to be determined when the plan or transaction

which gives rise to the claim is challenged as inequitable is “whether, w/in the bounds of reason and fairness, such a plan can be justified”

Uniform Fraudulent Transfer Act §4(a)

Arnold v. Phillips: Arnold calls $75k loan to business is equity contribution so not a loan that is equitably subordinated. Additional income after inception is a loan – adversity later can necessitate corporate borrowing to meet its needs but must document loan as necessary for housekeeping

Problem #5SCM, pg. 4

A. Theory to recover from PK: Try to p.c.v. of PK/ Harmann – look at factors of single economic entity Does PK have its own BOD and corporate housekeeping to prove? Was there commingling and siphoning of funds? Common control over both? Harmann wearing creditor hat so go after b/c tort victim is involuntary creditor –

get rid of his claim by equitable subordination

PART C: CORPORATE STRUCTURE

Class #6: Distribution of Corporate Powers

Directors Power:

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DGCL 141(a): Corporations are managed by or under the direction of the BOD, except to the extent as may otherwise by provided in the charter.NYBCL 701: Business of corporation should be managed by the BOD; each member must be at least 18 (sorry Hanah Montana)ALI-PCG 3.01: contrasts by saying that the management of a publicly held co. shall be conducted by and under the supervision of the corp.’s principal senior executives (this recognizes modern corporate governance)

Shareholder Power:Voting: Each shareholder’s voting power is directly tied to amount of her capital contribution, as votes are allocated on a per share basis. Can vote on amendments to charter DGCL 242(b), fundamental transactions (mergers DBCL 251, dissolution DGCL 275, substantial sale of assets DGCL 271 ), elect (and in some cases remove BOD – but don’t normally get to vote on replacement (DGCL 144)), amend by-laws (can share that power w/ BOD by stating in charter DGCL 109(a))

Removing BOD Members:NY 706(a): can remove with causeNY 706(b): can remove w/out cause only if charter or by-laws allow. If removed then shareholders elect replacement if removed without causeDGCL 141(k): shareholders can remove directors w/ or w/out cause

Election for replacement:For vacancies (generally): the remaining BOD members are usually allowed to appoint someone to act as a board member for the remainder of the termNYBCL 705(b): shareholders who oust can vote for a new director

Schnell v. Chris-Craft (DE)Pg. 166, CB*Amended by-laws to move up annual meeting is legal but inequitableFacts:

Δ sought to enjoin management to accelerate date of annual meeting to reduce time for proxy contest to make it more difficult for sh/holders to wage a successful proxy fight

DGCL 109: corp. charter can give power to s/holders to amend by-laws but they can share that power with BOD if charter allows

In this case, s/holders gave directors power to amend by-laws so their action was legal statutorily and according to the charter BUT under the circumstances their actions were inequitable b/c they put their own needs ahead of s/holders

Holding: Δ breached fiduciary duty of loyalty so held for Π

Leveraged RecapitalizationLeveraged recapitalization: involves a company’s incurrence of large amount of debt. The goal is to put a substantial amount of cash into the hands of the company’s common

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stockholders by leveraging the company’s assets. To achieve this goal, the company will borrow large amounts of debt and then distribute the proceeds to its stockholders in the form of an extraordinary dividend.

A stockholder vote is not required The company becomes highly leveraged, its assets are used to secure the new

debt, and its cash flow going forward services the new debt Shares become much less valuable – but has potential to enhance value of corp

b/c shareholders can reinvest Common s/holders have greatest interest in company going forward Creditors hate b/c c.s. holders have $$ and the leverages recap incurs high interest

making it harder for company to pay off and puts company at risk for insolvency But shareholders could care less b/c they have $$ and if corp goes under they are

ok and creditors aren’t ahead of them in line Often employed when confronted with a hostile takeover bid to put more $ in the

hands of s/holders than that being offered by a hostile party

Blasius v. Atlas (DE)Pg. 167, CB*Shareholders rather than management propose a leveraged recapFacts:

Π acquired 9.1% of Δ’s common stock making them the largest s/holders Π believed Δ was poorly managed and encouraged Δ to implement a leveraged

recap. Blasius’ leveraged recap called for: (1) payment to c.s/holders an aggregate

dividend of $35 mil + stock option proceeds and proceeds of sale of certain operations; and (2) payment of non-cash dividend = $125 mil principal amount of 7% Secured Subordinated Gold-Index debentures (a debt security that is like an I.O.U.)

Δ reacted negatively to this so Π by-passes management w/ written consent DGCL 228: Action through written consent: any action that could be taken by

s/holders at a meeting, can be taken w/out a meeting w/out notice to s/holders if they deliver to the company written consent telling the company to take action.o You need the same number of votes you would need in a s/holder meeting

(s/holders of at least 51%)o You have 60 days from the earliest date of consent to get all the remaining

consents in to have that action be effective NYBCL 615(a) Blasius’ written consent sought to (1) adoption by s/holders of a precatory

resolution (a request that is not mandatory) recommending the BOD develop and implement a restructuring proposal; (2) amend Δ’s by-laws to expand BOD members from 7 to 15 (max allowed in by-laws) and (3) elect the 8 new seats which would give them a majority on the board

Δ responded by voting to amend the by-laws to increase size of BOD from 7 to 9 then filled the 2 seats with Δ friendly appointees (which allowed them to keep their majority control even if Π’s written consent passed)

Issue:

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Whether a board may validly act for the principal purpose of preventing a company’s stockholders from electing a majority of new directors

Can a board act for the principle purpose of preventing s/holders from electing a majority of new directors?

Law: DGCL 141(a) Business Judgment Rule: a presumption that in making a business

decision, the directors of a corp. acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interest of the companyo Shareholder has burden of overcoming the presumptiono Policy: business decisions should be made in board room, not court room w/

20/20 hindsight – if BJR applies, you have to show court that the action had NO RATIONAL business purpose, in order to have a court rule it voidable

** Doesn’t apply in this case b/c this is clearly a corporate governance issue (purpose of action was to impede s/holders and expanding the BOD does not have to do with business judgment)

Unocal rule: When taking defensive actions (which have as a byproduct protecting your own jobs), there must be some sort of threat, and the action taken must be proportional**But defensive response here is to keep the status quo which is a conflict of interest b/c not necessarily looking out for what’s best for corporation, instead they were trying to protect their jobs

Holding: Compelling justification test: The board must have a compelling justification

for taking unilateral action, the primary purpose of which is to interfere with or impede the exercise of the stockholders voting franchise

MM Companies v. Liquid Audio (DE)Pg. 187, CB*DE examines the Blasius StandardFacts:

MM (owns 7% of LA stock) sends letter to LA BOD discussing willingness to acquire LA which includes proposal to change by-laws to add BOD members and MM had nominees already

LA responds by (1) announcing stock-for-stock merger w/ Alliance Corp.; (2) postponed annual s/holder mtg. and held a special mtg. to vote for merger; (3) proposed stock by back if merger vote passed – which would induce holders to vote in favor of merger b/c s/holders would own stock in LA and Alliance; (4) LA BOD amended by-laws to add 2 seats and filled them with 2 LA friendly seats

BOD rationale for expanding the Board was that eh 2 nominees were really great people and the company will benefit from the experience, and also, that if MM was successful there could be acrimony in the board room

Chancery court held for Δ directors claiming that the board proposed to expand the board primarily b/c they wanted to diminish the influence of any nominees of MM at least in numerical terms

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DE Sup. Ct. reviews the Chancery court’s decision and notes that the standard of judicial review is dispositive of who has the burden

The choices of review are: BJR (favors Δ- co and directors) – Π/ s/holder has burden of overcoming the

presumption of BJR. If they can’t prove then game over but not exactly game over the board must show that it was a rational business purpose. So if burden isn’t met

Blasius compelling justification (favors Π –s/holders) – DE ct rarely applies – focuses on struggle between s/holders and directors.

Unocal (favors Δ-directors) - focus on defensive actions by BoD - Δ has burden of proof. Defensive measure must be proportionate and reasonable in relation to the threat posed. An action is not reasonable in relation to the threat posed if it is Draconian (defensive response that precludes any possible takeover, despite what the offer is, it wouldn’t be enough, or it would be coercive to their s/holders into doing something they would prefer not doing. Anything in this range of reasonableness is allowed by DE courts)

Holding: In this case, Δ’s action affected s/holders, so the compelling justification and

Unicol standard appeared to be triggered. Ct. said that Δ was impeding the s/holder voting and there needs to be a justification and once that is satisfied then you can satisfy the lower Unocal test (but no one ever passes the compelling justification test)

Δ/directors board expansion was invalid b/c they didn’t meet the compelling justification test so Δ’s action was invalidated as an inequitable act

Williams v. Geier Pg. 84, SCMFacts:

Facts giving rise to the dispute happened in ’85 (height of hostile takeover boom) but wasn’t decided until ‘96

Δ Milacron and Π minority s/holders Publicly traded company but Geier family owned or controlled in excess of 50%

stock, all the rest were held by s/holders in the marketplace. 10 directors, 3 of whom were inside (employed by corp and most likely a senior

executive that happens to sit on board) and the remaining 7 were outside (independent, disinterested parties, no affiliation with corp other than the fact that they sit on board)

DE court gives a great deal of deference to decisions make by an independent committee, the DE chancery court will bend over backwards to make sure those decisions are respected by the board)

Δ’s recap plan offended Π, the plan was to provide for a tenure voting plan which involved Δ amending its charter so that c.s. holders would be deemed by fiat to have 10 votes per share instead of 1, so new buyers would only be entitled to one vote per share but after 3 years the buyers would be entitled to 10 votes per share.

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New shares would be entitled to only 1 vote, until the buyer held the stock for 3 years and then it would convert

Recap plan sought 2 objectives: (1) reduce the level of exposure to raiders (those conducting hostile takeovers, feeding on corporate vulnerability based on hurting business cycles- someone who wants to buy the company when the stock prices are low); (2) provide the board with a corporate structure, which gives the board the best opportunity to evaluate and negotiate in the best inters of s/holders, any proposal to acquire the company (huge impediment in being taken over)

How to achieve these objectives: (1) deterred a hostile party from providing a hostile tender offer (sending offers to purchase directly to s/holders – company can’t do it but it is still a self tender offer; (2) going private transaction is when the company tries to buy back all shares it must comply with the Williams Act of SEC – govt. got involved b/c people were messing w/ s/holders so govt. involvement was necessary b/c s/holders didn’t want to be left out.

Tender offer rules mandate a time period in which that offer must be open by law 20 days.

Hostile tender offer: someone is doing it w/out that company’s BOD blessing Friendly tender offer: an offer made w/ BOD blessing w/ terms typically

negotiated in advance Any hostile party that acquired shares in a tender offer would see the votes go

from 10 – 1, so the acquiring corp would have to by significantly more than 50%, Geier family owns more than 50% and they won’t sell w/out thinking it’s a good deal so it becomes impossible to take control of the BOD via hostile takeover

Π alleges Geier family want to sell some stock to get cash, yet they don’t want to give up control of the company, so they did this scheme – families retained shares have 10 votes and sold shares that have 1 vote – so Geier’s could sell 30% of shares and still have control

Holding: The statements here are coercive b/c if the shareholders did not make the 2/3

majority vote, then their stock would be de-listed from the NYSE and would no longer be able to be traded or sold. Coercion – shareholders vote on a particular issue NOT ON THE MERITS. Here, compelling justification does not apply b/c there is s/h approval of this amendment.

Notes from class: By modifying the votes p/sh – same implication as Blasius b/c reduces # of votes

and disenfranchises minority s/holders To modify the charter the BoD must approve then obtain s/holder approval then

file amendment to charter w/ Sec. of State. If s/holders have approved the BoD can refuse to submit the amendment if they change their mind on the amendment DGCL 242 (c): this right is only given if explicitly in the charter

Π wanted Blasius standard b/c BoD plan impeded their right to vote for directors of their choosing indirectly based on # of votes

Class #7 Authority in General

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Agent: is a person who by mutual assent acts on behalf and subject to control of another – the principal. 2 types of agents:

General: authorized to conduct a series of transactions, covering a wide spectrum of activities with some continuity of services (i.e. corporate officer)

Special: authorized to conduct only a single transaction or only a series of transactions not involving the continuity of service

Principal: person on whose behalf and subject to whose control an agent acts. 3 types of principals:

Disclosed: when an agent and a third party interact, the third party has notice that the agent is acting for a principal and has notice of principal’s identity

Partially disclosed: when an agent and a third party interact, the third party has notice that the agent is acting for a principal but does not have notice of principal’s identity

Undisclosed: when an agent and a third party interact, the third party has no notice that the agent is acting for a principal.

Authority: Actual: focus is on relationship between agent and principal, agent’s belief. The

principal’s words or conduct would make a reasonable person believe he was authorized to act.o Express or implied: if you have authorized someone to sell your house, you

impliedly authorized them to advertise for saleo Incidental: ensures that the main purpose will be fulfilled

Apparent: focus is on 3rd party. Words or conduct of the principal would make a reasonable party in the 3rd party’s shoes believe that he principal’s agent was authorized to act.o Power of position: Actual and apparent authority typically go hand-in-hand

Ex. Reasonable for 3rd party to believe that the Treasurer can sign checks Ex. If treasurer never given explicit authority to write checks, instead,

power given to comptroller of corp. Nevertheless, it is reasonable for a 3rd

party to believe that the treasurer could write checks so – corp is bound Agency by estoppel: similar to, or subsumed within, apparent authority. An

alleged principal will be held liable for the actions of his purported agent if an innocent 3rd party changes her position or:o Principal takes actions to induce 3rd party to believeo Alleged principal knew of the 3rd party’s belief, but did not take adequate

measures to remedy mistaken beliefo Similar to promissory estoppel in that there is no actual K

Inherent: the authority of the agent to take action that a person in the principal’s position should have reasonably foreseen that the agent would have taken even though the agent is not authorized to do those specific actions.

Ratification: after the fact approval. Principal with material knowledge of the facts, either treats the conduct as authorized , or justifiable if he had such intentiono Express or implied: principal accepts benefits or approves it = ratificationso Principal and agent both must be in existence when agent does such action

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Ex. Overzealous corporate officer entering into a transaction and when the board learns about it, the corp starts accepting benefits and paying for it

Liability: Principal 3 rd Party: principal liable if agent had any of the 5 types of authority 3 rd Party to Principal: if principal is bound, 3rd party is bound to perform.

EXCEPTION: If undisclosed principal then 3rd party is not liable with the transaction if the principal or agent knew that the 3rd party would not deal if the 3rd

party knew the identities of the principal or agent. Agent 3 rd Party: if agent had authority, he is not bound to 3rd party unless

principal was undisclosed or partially undisclosed. Agent Principal: if agent had actual authority, then agent not liable. If

apparent authority, then he is liable to principal for damages. Ratification probably follows apparent authority. No settled law for inherent authority.

Principal Agent: if agent acts with actual authority, then no liability. Principal must indemnify the agent for any damages paid, if the agent does things correctly and is sued by 3rd parties

Reading v. Attorney GeneralPg. 23, CB**Agent must act solely for the benefit of the principal

Action by Directors - Formalities Required for Action by the Board:

Models of Corporate Governance: Traditional – managed by BoD Modern – function of board is to monitor (watchdogs) the senior executives who

manage the corp ALI-PCG 3.01

Constraints on Directors: Time: meet only 6 – 12 times per year so 48 – 72 hours per year focusing on the

management of corp. Information: not unusual for directors to receive materials very shortly before a

meeting or at the meeting. There is no staff to help you look at the info and see if it’s accurate so DE 141(e) - directors are entitled to rely on records prepared by officers and opinions and reports by outside advisors. NYBCL 717(a) is the same provision, must be done in good faith. Directors don’t ask for more info or on a more timely basis, there is generally a grimaced look and it shows a level of mistrust

Composition of BoD: it is not uncommon to have individuals who are closely tied to the top executives. Typical BoD members are current or past executives, considered inside or independent directors.o Distinction between contrary points and voting against CEO’s wishes

higher tolerance for contrary statements, as opposed to voting no.

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o Lawyers, accountants, investment bankers are on board, need a nexus. They will usually not rock the boat w/ the CEO

o Friends of CEO considered outside independent directorso Major stockholders – they usually are talking about their money and nothing

has a greater interest to them, most likely to rock the boat of the CEO

Board of Directors: Election

Staggered BoD: Members are broken up into typically 3 classes, Class 1 up for reelection this year, 2 the next, etc. It is a rolling election process, only one class per year is up for re-election

A company would want this b/c at any given moment there is one class of director who has been there and the new directors will benefit from the continuity

Anyone who wants to take over the BoD in a hostile proxy fight would need to win 2 annual elections to replace the majority on the BoD, so it takes a minimum of 13 months – most companies would not want to wait around for 2 elections

Companies w/ staggered boards and poison pills are almost impervious to takeovers

DGCL 141(d): board can be divided into 1,2 or 3 classes and board is up for election in successive years. Provision can be in certificate of incorporation, or initial bylaw by sole incorporator (adopts initial set of directors and bylaws) or put in later on if s/holders adopt.o Shareholders hate staggered boards b/c they stop takeovers – so best time to

add it in is right before you go public, s/holders will not buy the continuity argument

NYBCL 704(a): notes that you cannot mathematically divide directors into one class. You can divide into as many as 4 classes. Differs from DE: requires that directors be divided into classes as equally as possible.o It can possibly take 3 years for a takeover.

Board of Directors: Approval of ActionsAction can only be taken in 1 of 2 ways:

Unanimous written consent: any action that directors can have in a meeting can do it outside of a meeting as long as unanimous consent by directors (issuing stock, S election, relieving sole incorporator of liability, and appointing directors). DGCL 141(f), NYBCL 708 (b)

Regular and special meetings: Need quorum and appropriate vote (in person or conference call)o Quorum: minimum # of directors law requires to be present for legally

binding action. Default is majority of the entire authorized board. o DGCL 141(b), NYBCL 707, 709(a)(1): Can change quorum threshold to

require greater than a majority but you cannot lower to a number less than 1/3. Appropriate vote : assuming a quorum, you need a majority vote of directors

present at the meeting. Default is majority.o DGCL 141(b), NYBCL 708(d): Can require super majority.

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o DGCL 141(b), NYBCL 709(a)(2): Cannot be lower than majority.

Shareholder voting:o S/h can only vote for directors and fundamental transactions (mergers,

amendments to charter, dissolution)o Plurality: only top vote-getter wins

Straight/traditional voting: You can vote the number of shares you own for each nominee.

Majority s/holder can elect ALL directors DGCL 216(iii): unless cert. of incorporation or by-laws, top vote-getters win

(plurality) NYBCL 614(a): plurality vote can only change in the cert. of incorporation NOT

by-laws.Cumulative voting: A s/holder can cast for any single candidate or for two or more candidates, as chooses, a number of votes equal to number of shares she holds times the number of directors to be elected

Cumulative voting MUST BE IN CERT. OF INCORPORATION DGCL 214 and NYBCL 618: s/holders may cumulate their votes only if cert of

incorp. allows it Policy: helps minority s/holders ensure they get to elect at least one person to

BoD to represent them. It doesn’t guarantee it but gives them a chance. Best time to add cumulative voting provision in charter is at time of incorporation

otherwise majority s/holders will never vote to approve it

Formula to determine how many directors you can elect:

N = (X) x (D+1) S

D = # of directors to be elected (not number of nominees) N = # of directors you get to elect X = # of shares you own S = total # of shares to be voted assuming 1 vote/share. If you have 100 shares (X), 5 directors are to be elected (D), there are 1000 shares

outstanding (S). To determine the fewest number of shares you can own in order to elect 1 director

use the same formula but N=1 and solve for X (just work backwards). To determine 2 directors N=2, and so on.

Shareholder Meeting:In order to have a vote of stockholders to be legally binding, you need to have a quorum of stockholders present and appropriate number of votes (same as directors)Quorum:

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DGCL 216: the cert. of incorporation or by-laws can specify a quorum, but cannot be less than 1/3 of the shares needed for a meeting. If you don’t have a quorum specified, default provision is the majority of stockholders needed to vote.

NYBCL 608(b): you can have less than a majority, but not less than 1/3. You can have a higher quorum requirement, but only cert. of incorporation can provide for it. DE does not allow this

608(c): quorum requirements are met at the BEGINNING of the meeting – so people can leave during meeting and it won’t affect quorum.

Appropriate number of votes: In DE, the default rule is a majority vote present or by proxy. DGCL 216(ii) or by-laws can establish a threshold contrary to a majority. Assuming no tinkering of voting requirements, you need at least 26% of the

shares. Under the default rule, stockholders who own 26% of the shares can control.

Abstentions:NY and DE very different.

DE: Abstentation equals a ‘no’ vote NY: Abstentation counts for quorum but not for votes NYBCL 614(b): an action is approved if a number of votes cast in favor

outnumber those against. Only applies to those who vote. Hypo: quorum is 500; 200 abstain; 175 vote against; 125 vote in favor. In NY it

is passed but in DE it does not pass – need 251 votes in favor

Proxy Voting:NYBCL 609(a): every stockholder entitled to vote may authorize another person to act for him by proxy.In NY, under NYBCL 609(b), a proxy is effective for a period of time up to the date specified. If no date is specified, a proxy can be effective no more than 11 months after date of issuance (only lasts for 1 annual meeting).Proxy holder must vote as s/holder instructed. EXCEPTION: Irrevocable proxy: gives the proxy holder discretion as to how he wants to vote.Proxy must say on its face that it is irrevocable, and must be given to one of:

NYBCL 609(f)(1): A pledgee: ex. pledging shares as return for a loan. During a term of a loan, the bank allowed to vote.

NYBCL 609(f)(2): Someone who has purchased or agreed to purchase the share (record date problem). When you have shares of a publicly traded company, the stockholder who holds shares at the record date gets to vote, even if they sell afterwards.

NYBCL 609(f)(5): A person designated under a valid stockholder’s agreement. Ex. trading voting rights for cash.

DGCL 212: pretty much the same as NY but some differences. DGCL 212(b): In DE, if you don’t put an expiration date, the proxy lasts for 3

years from date of issuance. But proxies are still revocable at the stockholder’s will.

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Irrevocability: under DGCL 212(e), proxy must state on its face that it’s irrevocable AND must be coupled with an interest.

Coupled w/an interest: person receiving the proxy has some nexus with the shares -essentially same as NY’s 609 (f) and (e)

PART D: CORPORATE FIDUCIARY DUTIES

DUTY OF CARE

D uty of Care: protection from harm to s/holders by sloppy/negligent decision making by BoD. Duty of care analysis is an analysis of the decision making process, not the decision itself.

NYBCL 717(a) and RMBCA 8.30: A director shall perform in good faith, and exercise that degree of care that person in a like position would exercise.

DGCL does not have duty of care provision Subjective – in like position as director in question (same skill set, i.e. lawyer,

accountant) and similar circumstances. Objective component – RPP 20/20 hindsight is not part of analysis. Duty to act and abstain - applies not only to actions that directors take

consciously, but also omissions.

Francis v. United Jersey Bank (NJ)Pg. 515, CB**With power comes responsibilityFacts:

Δ is in the business of reinsurance brokerage. Partnership corp. w/ 5 directors (2 bad sons and 1 old mother) Brothers engage in unscrupulous conduct – taking out “loans” and reporting them

as such on balance sheet but never paid interest or back to corp. account (siphoning of funds); did not disclose the “loans” as personal, and comingled funds of reinsurers and ceding companies with their own funds

Mother does not participate in running of corp and has no idea that sons are doing this

Issue: Whether Mrs. Pritchard was negligent in not noticing and trying to prevent he

misappropriation of funds held by the corporation in an implied trust? And if her negligence was the proximate case of the plaintiff’s loss?

Law: General rule : a director should acquire at least a rudimentary understanding of

the business of the corporation. Not required are detailed inspections of books but should regularly view financial statements.

“Dummy director” is not protection – all directors are responsible for managing the business and affairs of the corporation.

Holding:

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Δ had a duty and she breached that duty. Using the substantial factor test it was found that her breach was the proximate cause of Π’s loss.

Reasoning: Negligence/ breach of duty: She had duty to monitor financial statements and she

did not, had she reviewed them she would have noticed something “fishy” going on. She had a duty to object to illegal activity and if nothing was done about it, then she had a duty to resign. She did not do any of these things

Substantial factor test: the wrong that was committed must be a substantial factor in producing the harm: (1) commingling of funds; (2) stealing by sons; and (3) dereliction of duty by Δ – if she had spent anytime looking at records she could have put an end to it.

In re Emerging CommunicationsPg. 528, CBFacts:

Δ was financial expert in telecommunications sitting on the board of telecommunications company

Corp received merger offer that Δ knew was too low but did argue this when Houlihan (outside financial firm) gave the valuation

Holding: Δ could not rely on financial advisors b/c he had superior knowledge, equal to or

greater than Houlihan’s (DGCL 141(e) n/a)Reasoning:

The reasonably prudent director in his position (investment advisor in telecommunications) would have voted no on merger offer and his failure to vote no was negligence

In re Caremark (DE)Pg. 562, CBFacts:

Δ gives kickbacks to doctors illegally at lower level of corp. – fines and criminal charges result

Δ/ directors negligent for failing to be made aware of what was going on with lower managers – failed to be active monitors (linked w/ duty of care)

Holding: Caremark standard: whether the corporation made a good faith judgment that the

corporation’s information and reporting system is in concept and design adequate to assure the BoD that appropriate information will come to its attention in a timely matter as a matter of ordinary operations.

Caremark test/ evidence of good faith judgment: when there is a sustained or systematic failure by the board to attempt to ensure that the system exists.

Level of negligence needed to show breach of duty of care is gross negligence.Notes from class:

Despite Francis, the court gives great deference to BoD decisions b/c boardroom is where decisions should be made – not courtroom w/ 20/20 hindsight

Judicial developments that watered down duty of care:

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o Level of negligence in DE is gross negligence (Aronson case)o Business judgment rule: waters down level b/c it is presumed that directors

acted in good faith so Π has burden of overcoming it

Business Judgment Rule (Aronson)Protects directors in their decision making b/c presumptions that they made an informed judgment, in good faith (fulfilled their fiduciary duties). Presumptions:

Business decision Informed basis (duty of care) Good faith Made in best interest of corporation – put corp and s/h needs ahead of own (duty

of loyalty)To overcome presumption Π needs to show:

Improper motive OR Dividend constituted corporate waste, OR Show that dividend cannot be based on any reasonable business objective

Smith v. VanGorkom (DE)Pg. 544, CBFacts:

Δ is president of Trans Union arranged for leveraged buy out (LBO) to Pritzer and had Romans (CFO) figure out how much required to satisfy debts but never the fair price of the company and was not conclusive

Δ looked into MBO to sell his shares at $55 p/s – Peterson (controller) came up w/ this amount, which was 45% higher than current price (premium price), b/c whomever buys those shares will have control of corp

Δ decides against MBO b/c of conflict of interest but instructed Peterson to calculate the feasibility of LBO at that price

VG met w/ Pritzer and proposes the premium price at which he agrees VG wanted to be free to accept any better offer so Pritzer agreed but wanted to

secure shares at a certain price that he could sell to highest bidder if VG sold to 3rd

party Pritzer gives VG 3 days to make final decision so VG calls special meeting

Sept. 20 th meeting: Directors called in but with no indication as to the subject of meeting Voted to approve after only 2 hours which consisted of an oral presentation by

VG and no materials were distributed Lawyer – Brennan – tells BoD that fairness option not required by law Roman states that the amount proposed was neither a fair price nor valuation of

corp. $55 p/s was low end of fair pricePost- Sept. 20 th meeting:

VG signs agreement at opera w/out reading it Proposed amendments that VG asked for actually constrain Trans Union more

than the original terms but b/c he didn’t read it he was bound 2 interested outside bidders – GE and KKR

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KKR – approached by Roman – offered $60 p/sh but VG rejects offer so KKR withdraws offer

Issue: Did Δ make informed business decision at Sept. 20th meeting If they did not, whether directors actions taken subsequent to Sept. 20th were

adequate to cure any infirmary action on Sept. 20Holding:

Directors did not make informed business decision for three reasons:1. Directors did not adequately inform themselves of VG’s role2. DGCL 141(e) Good faith reliance. Meeting hastily called, directors did not

know what it was about, they had to make a decision in 3 days. Directors had a duty to inquire further – they could not blindly rely on VG. Blind reliance is NOT good faith.

3. Directors were uninformed of intrinsic value of company – no valuation made nor request of CFO or outside form to determine the fair price range

Directors “collective experience” argument did not remedy the Sept. 20th actions, it actually undermines their argument. Their unfounded reliance on premium and market test as basis for accepting Pritzer proposal demonstrates that they should not be deferred to (and will probably not be elected to another board ever again).

Board must not read every K or legal document, but, if it is to successfully resolve itself, then there must be some credible contemporary evidence demonstrating that the directors knew what they were doing and endured that their purported action was given effect

Aftermath of Van Gorkom: duty of care is basically deadSo NY and DE pass exculpatory charter provision statutesDGCL 102(b)(7): director relieved from his or her duty of care except for unlawful dividends but exculpatory charter provisions CANNOT protect from:

Breach of duty of loyalty Acts or omissions not taken in good faith Unlawful payments of dividends (can’t violate legal capital rules) A transaction from which a director derived an improper personal benefit

NYBCL 402(b): same exculpatory charter provision as DE**If charter does not contain exculpatory provision then Van Gorkom still applies

Malpiede v. Townson (DE)Pg, 580, CBFacts:

Δ “Fredrick’s of Hollywood” announced that it was looking for a buyer Knightsbridge offered to purchase outstanding shares so entered into merger

agreement for $6.14 p/sh MA had “no shop” provision that Δ could negotiate with other third parties for a

higher price but could not actively seek a higher bidder There were 2 other bidders – Milton and Veritas Milton dropped out

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Veritas offered $7.75 so Knightsbridge matched but added “no talk” provision (which is illegal according to Haas b/c by not talking w/ 3rd party bidders, Δ breached duty of loyalty b/c they are not maximizing s/h value), termination fee, appointment of non-voting board members

Veritas went all the way up to $9.00 but Δ rejected relying on Knightsbridge stated intention to vote its shares against third party bids, the no talk provision, and Veritas’ request for an option to dilute Knightsbridge interest

Π s/h bring suit under Revlon which said that if you put company up for sale, as a director your role changes from protector to salesman and it is your duty to get the highest price for s/h

Issue #1: Whether Δ breached fiduciary obligation to maximize s/h value (duty of loyalty)

Holding #1: Π alleges that CEO had conflict of interest b/c he was acting for his own best

interest b/c he was on both BoD’s but court held that one director did not dominate the others so merger was approved by majority of disinterested directors

Issue #2: Whether Δ was grossly negligent for failure to implement a defensive strategy

such as poison pill (duty of care)Holding #2:

Even if court had found a valid due care claim, the exculpatory charter provision trumps that claim.

D&O Insurance Director and officer liability insurance that insures against liability and legal

expenses. Technically it is indemnification insurance because it does not require the insurer to defend (although it does require the insurer to indemnify for losses, including defense costs), and the insurer’s obligation do not accrue until the claim is settled or adjudicated.

2 components: (1) corporate reimbursement, which insures the corporation against potential liability to officers and directors under the latters’ right to indemnification from the corporation; and (2) personal coverage, which insures the directors and officers themselves against the losses based on claims against them for wrongful conduct when they are not indemnified for the loss of the corporation

“claims made” basis: only coverage for events that arose during term of coverage and claim brought during term of coverage. Once a director resigns, he usually asks corp. to buy “tail” insurance that covers as long as the statute of limitations allows to protect from claims that arose while he was on BOD

DUTY OF GOOD FAITHDuty of good faith is tied in w/ duty of loyalty

In re Walt Disney Co. Derivative LitigationPg. 110, SCM

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Facts: Ovitz concerned w/ early termination during OEA negotiations so he wanted a no-

fault termination option (NFT) which provided options to be exercised upon termination

Ovitz did not perform well as president b/c he did not have same freedom as he did at CAA and he butted heads w/ Eisner

Eisner did everything he could to go around NFT but Ovitz didn’t do anything worthy of being fired w/cause so he had no choice but to terminate w/out cause

Disney paid him $140 million in accord w/ NFTΠ s/holders allege:

1. Δ breached duty of care2. Δ bad faith conduct3. Δ wasted corporate assets

1. Duty of Care: Focus on decision making process – consideration and approval of Ovitz fell short

of corporate governance “best practices” Ct. said that “best practices” would have been all committee members having

access to a spreadsheet laying out all possible scenarios (Ovitz terminated w/ and w/out cause for each year of employment K)

Committee could have presented that to BOD before they voted for Ovitz 9/26 mtg.: approved “term sheet” which summarized material terms but did not

lay out all scenarios, instead, it had figures and formulas that allowed members to come to the “best practices” result on their own (piece of puzzle, not whole puzzle)

Holding: while it was not “best practices” it certainly wasn’t gross negligence2. Bad Faith Conduct/ breach of loyalty:

Chancery ct. defines bad faith as “the intentional dereliction of duty, a conscious disregard for one’s responsibilities…conduct that is clearly disloyal to the corporation.”

First time court considers intent in duty of care case and not negligence Π has burden of overcoming BJR presumptions – prong of good faith Π claims this definition is erroneous b/c it materially changed the 2003 definition

but DE Sup. Ct. said it correct. Π claims it is erroneous b/c it was not properly tied to BOD decision making

process under duty of care but court says that there are 3 potential categories of bad faith but only 1st and 3rd hold up in judicial analysis: (1) subjective: intent to do harm; breach of duty of care and good faith: Π contends that by being grossly negligent directors breach both but ct. said no - duty of care and breach of good faith cannot be synonymous. To merge them would nullify the congressional intent of DGCL 102(b)(7) exculpatory provisions and DGCL 145 indemnification statutes and (3) intentional dereliction of duty: which is more culpable than grossly negligent conduct b/c does not involve traditional disloyalty b/c Δ did not gain anything – Δ did not put their own needs ahead of corporation’s.

Court says that Chancery court definition of bad faith is correct but falls short so they create their own definitions

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Bad Faith: disloyalty w/out self-interest Breach of Loyalty: disloyalty w/ self-interest Holding: Directors certainly did not gain anything by firing Ovitz and thus did

not put their own needs ahead of the corporation’s3. Waste of Corporate Assets:

Π claims NFT was wasteful Very difficult for Π to prevail – must show that “the exchange was so one-sided

that no business person of ordinary, sound judgment could conclude that the corporation has received adequate consideration”

As a Π, if you didn’t overcome BJR presumptions then must show Δ irrationally squandered corporate assets in order to prevail

Holding: b/c Disney needed a high enough NFT to attract him from CAA and they were contractually obligated to pay it was not a irrational

Orvitz did not do anything to induce his termination b/c he had no control, plus, he was fired w/out cause and did nothing egregiously bad.

DUTY OF LOYALTY1. Self-dealing transactions: Director directly transacts w/ corp.

Concern: if you are part of the deal and it’s affecting you personally, you are liable to put your interest ahead of the corporation. The other directors have to approve it.

2. Interlocking directorate: Transaction between two different corporations w/ director on both boards (Kodak – Fletcher v. Atex) Concern: you might put the interests of one company and its s/h over another.

But, there are situations where you, as a director, may have a bigger financial interest in one over another. (Lewis)

3. Usurpation of corporate opportunities: Where a director or officer learns of a business opportunity and rather than offer it to the corporation, she usurps it herself and uses it for her advantage. Concern: she is thinking about keeping the money for herself (Harris)

4. Entrenchment activities: Directors making decisions the result of which secure their positions as directors. Entrenching themselves in office. Concern: directors who are doing things that ensure their jobs and job safety may

not be making the best decisions for the corporation or s/h.5. Action that favors one class of s/h over another: Sometimes companies have one

class of stock outstanding, benefiting one s/h over another, and the one that is not helped claims that it is owed money. Concern: duty of fairness in regards to the s/h.

Self-dealing TransactionsGeneral rule of 1880: transactions voidable at option of s/h or BOD even if transaction was fair.

Policy: it is human nature not to be able to disenfranchise their self-interest from interest of corp.

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Cumberland Coal & Iron: the disinterested directors are put in an uncomfortable position b/c they have to scrutinize and check the transactions made by one of their fellow board members

General rule of 1910: K valid if approved by disinterested majority of directors and not found to be unfair or fraudulent by the court if challenged.General rule today: DGCL 144(a) : Interested party statutes/ cleansing process No K or transactions btwn a corp and one or more of its directors OR a K or transaction btwn a corporation and one or more entities (interlocking director problem) shall be void or voidable even if the interested director is there and votes in the transaction if one of three things occur (cleansing process):(1) Full disclosure + disinterested director approval: if K is approved by a majority of disinterested directors, it will be valid so long as the disinterested directors were told of the director’s interest in the deal. True even if less than quorum of the board.(2) Full disclosure + stockholder approval: if the conflict of interest is disclosed or known by the s/h, and they approve in good faith, then the mere fact that there was a conflict of interest cannot be challenged on duty of loyalty grounds.(3) Objective fairness: if the K or transaction, as determined by the court, is objectively fair to the corporation then ok.**when challenged on grounds that disclosure made was inadequate then the conflict was not fully understood.DGCL 144(b): Interested directors count for quorum determination but do not count if you are trying to cleanse.

NYBCL 713: 3 distinctions from DE For a transaction btwn a corp and 3rd party to fall w/in 713, there must either be

an interested director or the director must have a substantial interest in the other corporation. In DE, not substantial but you can infer.

NY imposes a tougher voting standard. 713 (a)(1) requires disinterested director approval comply with 708(d). Approval by a majority of disinterested directors present; if no quorum then must be unanimous. In DE, only majority of disinterested required.

713 (b): if the procedure met and cleansed under the first two processes then the transaction cannot be challenged in court. If the procedure is not met then the burden of proving that K is fair and reasonable to the corporation is up to those interested in transaction. In DE this is disjunctive – Π can still challenge in court even if cleansed.

Hypothetical: cleansing by disinterested director voting*NY is more stringent than DEBOD meeting with 15 directors but only 13 shoe up. Default provision is a majority present so a quorum is present.Case 1: 4 interested, 9 disinterested

NYBCL 713(a)(1): a self-interested transaction can be approved only if 1 of 2 things occur. If any of the disinterested voters vote ‘no’ then approval must comply with 708(d). OR it can be approved if 7 of the 9 vote in favor of it.

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Interested votes don’t’ count. Up to 2 people can vote ‘no’ to comply with 708(d) (majority present)

Case 2: 5 interested, 8 disinterested and 2 vote ‘no’ In DE, all you need is a majority of disinterested and since there are 8

disinterested, you only need 5 votes In NY, you need 7

Case 3: 9 interested, 4 disinterested According to 708 you don’t have enough. If you don’t have enough and fall

bellow majority voting requirement, then all disinterested have to vote ‘yes’. Other option is s/h approval

In DE, you only need a majority vote so you only need 3 to vote ‘yes’, not 4

Self-Interested Transactions/Interlocking Directorate

Lewis v. SLEPg. 609, CB

Facts: LGT runs tire dealership and SLE owns land & building that LGT used 4 brothers – Donald (Π) and Alan, Leon, Richard (Δ) Interlocking directorate: Δ were directors and s/h of SLE and LGT. Π was only

s/h of LGT This structure created incentive for lopsided transactions b/c Δ would get all

gain and Π would get all the harm Δ treated SLE as a shell to protect LGT Δ leased land to Π pursuant to lease agreement that expired but no new lease

agreement was entered into and Π paid same amount The s/h agreement stated that each child not a s/h by 1972 had to their sell SLE

chares to LGT at book value Π claims that if Δ had charged market rate for rent after lease expired it would

have raised his book value to sell shares Π brings suit action Δ for wasting SLE assets by grossly undercharging for rent

Law: BJR not applicable b/c it presupposes no conflict of interest but here there is

an interlocking directorate (if you want to disable BJR then show conflict of interest)

Δ has burden of proving that transactions between SLE and LGT were fair and reasonable 713(b)

Reasoning: SLE’s expert showed that rent should have been higher which disproves Δ’s

argument SLE says LGT could not afford higher rent but court held that they should have

kicked LGT out and found tenant that could pay market rate Holding:

Because Δ didn’t find a tenant that could pay the market rate they were wasting corporate assets

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Damages: Δ was found j&s liable for fair market value determined by accounting

Usurpation of Corporate Opportunities

Northeast Harbor Golf Club v. HarrisPg. 658, CB

Facts: Δ purchased two parcels of land surrounding golf course that she was president of

at time she purchased Both opportunities were presented to her in her capacity as president She did not disclose to the BOD until after she purchased them but told them that

she did not intend to develop at that time Trial court found in favor of Δ b/c Π was unable to prove the corp was in the

same line of business (buying real estate) Sup. Ct. used this opportunity to change the ME usurpation law

Law: Line of business test: If a business opportunity is presented to the officer or

director which the corporation is financially able to undertake and in the line of business of the corporation, then officer or director cannot seize the opportunity for himself. An opportunity is in the same line of business if it is so closely related to the corporation that the director would be in competition with the corp. if he took advantage of it. (Maine and Delaware)o Problem with this test is that the line of business prong is too difficult to

determine and a corporation can usually find financing sources when good opportunities open up to them.

Fairness test: asks whether the director or officer is being fair and equitable to corp in usurpation of opportunity (Massachusetts)o Problem with this test is that there are no defined guidelines of what

“fairness” means Two-step test: same as line of business test ALI-PCG 5.05(a): General rule is that you cannot undertake a corporate

opportunity for yourself unless 3 things occur:o You have to offer the opportunity to the corporation after fully disclosing your

conflict of interest and fully disclosing the opportunity itselfo The opportunity has to be rejected by the corporationo Either one of 3 things has to occur:

The taking of the opportunity was objectively fair to the corporation OR The opportunity was rejected in advance by disinterested directors in

accordance with the BJROR Rejected in advance or ratified after the fact by disinterested shareholders**Same as DGCL 144 just in reverse

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**Cannot constitute waste if corp rejects it*Financiability does not get discussed except in comments of statute so its considered but not emphasized

ALI-PCG 5.05(b) : Corporate opportunity defined: o In connection with the performance of functions as a director or officer, or

under circumstances that should reasonably lead the director or officer to believe that the person offering the opportunity expects it to be offered to the corporation OR

o Through the use of corporate information or property, if the resulting opportunity is one that the director should reasonably be expected to believe would be of interest to the corporation OR

o Any opportunity to engage in a business activity of which an OFFICER becomes aware and knows is closely related to a business in which the corporation is engaged or expects to be engaged

ALI-PCG 5.05(c) : Burden of proof: o If not properly rejected or ratified, then director or officer has the burden of

showing that the taking was fair. If rejected, the burden is on the other side. Rooted in disclosure

Holding: ME adopts the ALI as law and remands case back to lower court Π wins but b/c statute of limitations ran out they were not entitled to judgment

Entrenchment Activities

Unocal v. MesaPg. 1124, CB

Facts: Δ (T Boone Pickens/ takeover artist) initiates hostile takeover Mesa’s 2-tier “front end loaded” tender offer:

o 1 st tier (front end): tender offer to buy 37% of shares at $54 p/s (already own 13%)

o 2 nd tier (back end): as majority s/h they need to get rid of minority so they squeeze out w/ a merger

Once own more than 50% - control of BOD of target corp. and to get approval for merger they need s/h approval so Δ wanted to get rid of them so they got merger consideration: $54 worth of IOU’s (not cash, like 1st tier). These securities were highly subordinated (“junk bonds”)

Ct holds this action was coercive b/c if minority didn’t tender their shares at front end then left w/ back end so they are coerced into tendering at front end even though the amount was low

Π rejects the tender offer b/c Goldman Sachs determined offer was inadequate through independent valuation (van Gorkom conducted no valuation which was their problem)

Unocal’s defensive measures:

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Conditional exchange offer: if 1st tier/front end was successful then Unocal offers to buy rest of stock at $72 p/s of debt securities and all s/h can tender at $72 – all s/h EXCEPT Mesa (“Mesa Exclusion”)

Strategy is that Mesa does not want to buy a corp that has incurred a huge amount of debt and it would leave them as sole s/h in a debt ridden corp.

Unocal argues that Mesa Exclusion was to adequately compensate s/h @ backend of Mesa’s proposal

Δ argues that Π breaches their fiduciary duty with Mesa Exclusion b/c they are being singled out from other s/h

Π argues that they owe no duty of fairness to Δ and the Unocal BOD acted reasonably and in good faith concluding that Mesa’s tender offer was coercive and inadequate. Further, Π argues that exchange offer was made in good faith, on an informed basis and in exercise of due care to protect s/h from Mesa’s harmful tactics

Law: DGCL 160(a): allows corp to selectively repurchase from specific s/h as long as

it is not for the primary purpose to entrench in office (which would breach duty of loyalty b/c for personal benefit, not corp.)

BOD’s power to act derives from its fundamental duty and obligation to protect the corp. from harm reasonably perceived, irrespective of its source

UNOCAL STANDARD: any defensive action will be protected by BJR presumption IF:o REASONABLE GROUNDS: Directors have to show that they had

reasonable grounds for believing that a threat existed. Must conduct an investigation in good faith (outside investigation by Goldman Sachs very good for Π)

o PROPORTIONALITY: The defensive measures you implement have to be reasonable to the threat posed. – Can’t kill a fly with a sledgehammer

Holding: Π’s decision to oppose tender offer was made in good faith belief that it was

inadequate Π entitled to BJR presumptions b/c had directorial power to oppose tender offer

and ok to undertake selective exchange b/c reasonable in relation to threat posed.Today:

State law still allows corp to select s/h from which to buy shares from (DGCL 160(a)

But, Williams Act passed which prohibits exclusionary discriminatory tender offers

Unitrin v. American GeneralPg. 1135, CB**Analyzes Unocal test and undermines it by defining draconianFacts:

Π has super-majority voting provision as defense for hostile takeover (requires 75% to approve) and share repurchase program to purchase 10 million shares on the open market at $50 3/8

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BOD held 23% collectively so to vote in favor of a merger would be virtually impossible

DE chancery ct. holds that super-majority is defense enough so refuses to allow Π to also have the share repurchase program but supreme court reverses

Holding:This is the proper Unocal Standard:Any defensive action will be protected by BJR if 2 thing occur:1. REASONABLE GROUNDS: Directors have to show that they had reasonable grounds for believing that a threat existed. Conduct an investigation in good faith.2. PROPORTIONALITY: The defensive measures you implement have to be reasonable to the threat posed – cannot be draconian

Draconian means coercive or preclusive Coercive would not allow s/h to vote against it (i.e. Williams v. Geier/ Unocal) Preclusive would make it impossible for 3rd party to ever purchase even if a great

price was offered. Disproportionate response smacks of entrenchment. Range of reasonableness: anything between preclusive and coercive.

Notes: DE ct. extremely management friendly Ct. bends over backward to make it work for Π and undermines Unocal so that

virtually every defensive strategy is ok

Revlon v. MacAndrews & ForbesPg. 1163, CBFacts:

Δ (Perlman/ Pantry Pride) tender offer for Π Π’s investment bank says Δ’s tender offer of $45 p/s is grossly inadequate (should

be in the mid-50’s range) Δ’s strategy was to acquire Π’s stock w/ junk bonds then “bust up” by selling

businesses separately b/c they are worth more separately than as a whole. This would drive up price to $60/70 p/s

Marty Lipton (WLRK) recommends that Π buy 5 million of their own shares which would sell to their directors so that they are in “friendly hands” (ESOP – employee stock ownership plan which is a trust for benefits of employees)

Δ ups bid to $42 p/s conditioned upon receiving at least 90% o/s stock (lower on face but essentially equal in view of completed exchange offer)

Π responds by senior subordinated notes – notes w/ covenants that limited their ability to incur additional debt, sell assets, or pay dividends unless otherwise approved by independent members of BOD (there were only 4 of 14 directors that were independent)

Δ announces new tender offer of $42 cash which is more b/c Π is so highly leveraged w/ all the debt securities

Π rejects Δ’s offer and authorizes management to negotiate w/ other parties in acquiring them (Π’s fatal mistake)

Π finds Fortsmann as their “white knight” and gives them financial information (did not give to Δ)

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Π’s stock plummets b/c they are so highly leveraged so Fortsmann makes new proposal – $ 57.25 p/s LBO w/ lock-up option to purchase Π’s most valuable division is 3rd party bought more than 40% then they could buy at bargain basement price (crown jewel), plus no-shop provision and cancellation fee. Fortsmann would support the value of notes in the secondary market (buying them as the price lowered)

Δ ups tender offer to $58 p/s conditioned on nullification of the Rights Plan (poison pill), waiver of the covenant, and injunction of Frontsmann’s lock-up

Δ seeks injunctive relief and enjoined the lock-up, no-shop, and cancellation fee provisions or agreement

Law: Re: injunction: Δ must demonstrate both a reasonable probability of success on

the merits and some irreparable harm which will occur absent an injunction Duty of loyalty comes into play here – “when BOD implements take-over

strategies there arises “omnipresent specter that a board may be acting in their own interests, rather than the interests of the corp and s/h”

Holding: Poison pill and Exchange Offer : were reasonable responses to perceived threat

HOWEVER when they put themselves up for sale 2 things happened:o Directors’ duties became that of an auctioneer (get the best price)o Defensive strategies are moot

Lock-up: did not encourage bidding so it ended auctiono Lock-up options and no-shop provisions are not illegal, but, they are only

permissible if they intensify bidding processo Cancellation fee only ok if is part of overall plan to thwart Δ’s effort

White knight: Π showed favoritism toward Frontsmann so it is not allowed b/c this was an auction and not a take-over so not creating level playing field. You are breaching duty of loyalty by not getting best price for s/h

Don’t have to get price but should accept the bid offering the “highest price reasonably available for the company” and can consider several factors:o Adequacy and terms of the offero Offer’s fairness and feasibilityo Proposed and actual financing of the offer and consequences of the financingo Questions of illegalityo Impact of both the bid and the potential acquisition on other constituencies

(provided bears reasonable relationship to s/h interest)o Risks of nonconsummationo Basic s/h interests at stakeo Bidder’s identity, prior background, and other business venture experienceso Bidder’s business plan for the corporation and their effects on s/h interest

Defensive Strategies: Charter provisions:

o Staggered BOD

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o Super majority voting provisions o Elimination of s/h ability to take action via written consento Limitations on ability to call special meetingso Limitations on expanding size of BODo Tenure or time phased voting system: each sh receives multiple votes but

multiple votes disappear when the share is transferred or sold (Williams v. Geier)

o Two- tier voting stock (Unocal)

Poison pill: (shareholder rights plan) distribution of stock, stock rights, or other securities that have special redemption or conversion properties that make it unattractive for bidder to want to take overo Negotiating chip to get target corp on level playing ground as bidder

Asset-based defensive strategies: o Lock-up most common is “crown jewel” where the target company subjected

to hostile takeover sells its most valuable asset to a third party at bargain basement price making the takeover bidder lose interest

o Greenmail: target using its own cash to buy back shares of its own stock from a hostile party at a premium price NYBCL 513(c)

o Golden parachute: Large severance package in employment K that a target must make to senior managers upon the occurrence of a change in control of target

o White squire: target issues a large amount of newly issued shares to a friendly third party that agrees not to sell to hostile party in “standstill agreement”

o White knight: when target knows that it cannot stave off hostile party it will seek to sell to a friendly 3rd party buyer

o Pac Man: if hostile party initiates bid on target company, target company will turn around and launch a hostile takeover bid for the hostile bidder

Action that favors one class of s/h over another:

Sinclair Oil v. LevienPg. 688, CB

Facts: Δ: Sinclair holding company w/ 97% interest in Sinvin (Sinvin is a subsidiary

but not a wholly owned subsidiary) Π: other 3% s/h Sinclair Int’l wholly owned subsidiary of Δ Δ and Sinvin had interlocking directorate Δ dominated BOD – no independent directors Δ owed fiduciary duties to corp and minority s/h – the other 3%

Π alleged that Δ breached duty in 2 ways:1. Paying excessive dividends and not growing corp internally

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o Δ stunted Sinvin’s development which lead to de facto liquidationo Π alleges that BOD paid dividends to fill their own pocketso Dividends were paid in compliance w/ legal capital rule DGCL 170(a)o Δ wants BJR (burden on Π to overcome presumptions)o Π wants intrinsic fairness test (burden shifts to Δ)

INTRINSIC FAIRNESS TEST: directors or controlling s/h must show that the deal was intrinsically fair to the corporation and minority s/ho In parent-subsidiary relationship must show that controlling s/h used its power

to extract a benefit that is not available to minority To disable BJR, you have to show that no reasonable business objective or

improper motive. Improper motive – show that there were some opportunities that could

have been pursued, which Π did not

Holding for Δ: It was not self-dealing b/c every s/h received dividends – including Π so intrinsic

fairness test n/a BJR applies so Π must show improper motive to get dividends from Sinvin Π showed absolutely no business opportunities were even presented to Sinvin that

Sinclair usurped for their own benefit to the detriment of Sinvin

2. Π alleges Δ breached K between Sinclair and Int’l o Int’l made late payments and amount purchasedo Π alleges Δ purposefully breached for their own benefit

Holding for Π: Intrinsic fairness test (burden on Δ) – benefit of breach was for Int’l (100% owned

by Δ) to detriment of Sinvin (97% owned by Δ) Δ had no argument so failed to meet burden – no legal reason for breaching K

Notes: In order to avoid owing fiduciary duties, Δ should obtain 3% shares (they couldn’t

here b/c of Venezuela law that allowed them to get oil) but if they wanted to they could take action

DGCL 253 short form merger provision: if you own more than 90% then no s/h meeting or vote required, just file necessary paperwork

DGCL 262: minority s/h in short form merger can get appraisal rights so if they think they are getting too low of a price for s/h they can petition ct to compel majority for valuation to get fair value, but, burden is on Π/minority s/h to challenge the price and pay for valuation

Δ can also do reverse stock split

Jones v. Ahmanson (CA)Pg. 711, CBFacts:

Minority s/h in this case are account holders of Δ: savings and loan (Association)

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Majority (85%) decided that instead of doing a reverse stock split, to establish holding company and exchanged their stock for stock in the newly formed company (UF) which was essentially a de facto 250-1 stock split

During IPO the shares of UF were only offered to majority s/h UF was financed by debentures (debt securities) guaranteed by Association Eventually the funds dried up in Association rendering the minority’s shares

worthless while the UF shares skyrocketedHolding:

Δ did not pass intrinsic fairness test thereby breaching fiduciary duty owed to Π b/c they used Association’s assets to guarantee UF’s debentures which benefited majority s/h to the detriment of minority s/h

Reasoning: Δ could have created a stock split and created a marker for Assoc. stock or still

formed holding company but for Assoc. s/h and permit all s/h to exchange their shares before offering holding company shares to the public

Instead they used the holding company to maintain control while still selling shares and earning $ (just like the tenure voting structure of Williams v. Geier BOD)

Remedy: Π entitled to receive the appraised value of her shares on the date of exchange

with interest at 7% or sum equivalent to the FMV of a “derived block” of UF stock

Stock Splits1. Forward split: # of o/s increases while the p/s trading price increases which sells more shares so demand goes up thus driving up price

Ex: 2–for–1 double # of sh (pre-split sh x 2) divide of sh/2 (pre-split $/2) Stock split viewed by market as “bullish” – positive signal of managerial

confident that stock price will continue to rise Does not impact s/h economically but could potentially require s/h approval if you

don’t have enough authorized shares in charter

2. Reverse split: # of o/s decreases while the p/s trading price increases Ex: 1–for–2 divide # of sh (pre-split sh/2) double of sh (pre-split $ x 2) Reverse split viewed by the market as “bearish” – negative signal viewed as an

attempt to raise its p/s price through “smoke and mirrors” rather than by increasing earnings and growing corp.

Can also be used to squeeze out minority s/h (what Sinclair could have done if didn’t need Venezuelan s/h) – all other s/h end up owning a fraction of 1 share and thus will receive cash compensation for their fractional share pursuant to the terms of the reverse stock split

PART E: DERIVITIVE CLAIMS

Derivative Lawsuits:

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Lawsuits brought by s/h of a corporation on behalf of corporation. Derivative in nature b/c the s/h ability to bring the suit is derived by the corporation’s ability to bring the suit. The corporation has a reason to bring the suit and chooses not to defend itself. Corporation must be involved in the lawsuit as a nominal defendant (although it ultimately receives the benefit) to get its name in the pleading.

Requirements: one share is enough. You must own shares when you bring suit and you may have to continue to own during suit.

Can bondholders or preferred s/h bring a suit? No – no one other than common s/h can bring a suit. Exception to that is insolvency or bankruptcy b/c bondholders have the largest stake.

What if you own a bond convertible into common stock? Convertible bondholders cannot bring suit until they convert.

NYBCL 626: (a) You don’t need to own any particular quantity of stock. (b) You must plead that you own stock at the time the complaint was filed and that you own stock at the time transaction you are complaining.(c) Demand requirement plead w/ particularity what you have done to demand on BOD to take action and if not, why.Policy: BOD should be initiating suits, not s/h. BOD is first line of defense. If they aren’t aware of problem then give them time to fix before filing suit.

Direct v. Derivative Suit:Tooley v. DonaldsonPg. 919, CBSet forth test to determine whether direct or derivative suit:1. Who suffered alleged harm? Corp. or s/h?2. Who would receive benefit/ remedy? Corp or s/h?

Strike suits: the countervailing consideration is the potential of abuse through strike suits. Corporate equivalent of ambulance chasers/ nuisances. Professional plaintiffs with very few shares (financed by lawyers) will bring suits every time stock prices dip. The real winners are the lawyers of Π b/c they get a lot of $ and cases normally don’t go to trial

Part of settlement was Δ had to pay lawyer fees if the case goes to discovery so Π just needs to get past motion to dismiss to get to “land of discovery”

Corporation’s goal was to get motion to dismiss to send message to strike suit law firms and professional Π’s

Private Securities Litigation Reform Act: (§ 27 of Securities Act of 1933 and § 21D of Securities Exchange Act of 1934: 1934 Act governs secondary trading market and is usually implicated with derivative suits.

1. Certification requirements:

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Π must certify that she read the complaint, that she did not buy shares at the direction of legal counsel. Must list other strike suits that have been implemented in the last 3 years. That she will not receive extra compensation other than pro-rata portion.

Court appoints lead Π believed to be most capable (normally the largest s/h)and will appoint lead counsel

No longer rush to get to courthouse2. Pleading requirements:

Π must specify the exact statements of Δ that are allegedly misleading and why they think they are misleading. If Δ needs to act with a particular state of mind (i.e. fraud, intent), you need to plead facts with particularity that give rise to a strong inference of that state of mind. It must be in your complaint, thus must be in there pre-discovery – very difficult to prove w/out discovery.

State law of derivative suits: general need for a s/h to make a demand on the BOD to take action to protect corporation. Very often, the harm is not caused by 3rd party, but the BOD themselves so if that is the case then demand is excused (demand futility)

Marx v. AkersPg. 950, CB

When should demand be excused?1. DGCL 2-prong approach:

1. Conflict of interest – to make a complaint of demand futility, must please facts that creates a reasonable doubt that directors were not disinterested or not independent

If you can indicate facts suggesting defendant directors are conflicted and wouldn’t take action to protect corporation b/c personal involvement in benefiting then demand excused, proceed to court

Easier to prove2. Not valid business judgment – the challenged transaction was not product of valid

exercise of business judgment “Smell test”: does the transaction itself reflect the spirit of director

disinteredness? More difficult to prove

2. Universal demand:Π must always make a demand no matter what. You can bring an action only if 90 days have passed. Can bring earlier if BOD rejects demand or corporation would suffer irreparable harm

3. NYBCL 626(c):Reasonable doubt standard. Either on its face or decision itself calls into question their interestedness. Complaint must set forth:

1. Similar to DE conflict of interest: majority of directors are interested in challenged transaction. Either self-interest or lack of free will self-interest (people exerting their influence) OR

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2. Similar to smell test: directors did not fully inform themselves to extent reasonably expected under circumstances, OR

3. Similar to smell test: challenged transaction is so egregious on its face that it could not be the product of sound business judgment

PART F: SHAREHOLDER INFORMATION RIGHTS AND PROXY VOTING

Shareholder Inspection RightsGeneral standard: s/h needs “proper purpose” as to why you want to look at books and records

Easiest to see is the list of s/h so that you can communicate with them Can see financial statements but not process used to determine Record dates: BOD picks date for (1) dividend record date to determine which

s/h receive dividends; and (2) record date of s/h meeting to determine who gets to vote in the meeting

Proxy VotingSecurities Exchange Act 14 a-8: s/h entitled to submit issues for consideration at s/h meeting. The resolutions are not binding b/c BOD ultimately approves them. Proposals that do not need to be included: social policy proposals, illegal activity, fraudulent misstatements, personal grievances, immateriality, impossibilities, ordinary business operations, relation to dividends.

PART G: CLOSELY-HELD CORPORATIONS

Closely-Held Corporations: Company whose stock is only held by very few s/h. Owner-managed who receive salaries instead of dividends Not publically traded b/c no secondary market Formal K restrictions influence corporate governance and ability to transfer shares Treated like a partnership but incorporated to protect from liability w/ flow-

through tax benefit No reporting requirements under SEC Act of 1934

Donahue v. Rodd ElectrotypePg. 327, CB* Judicial response to closely-held corp problems

Facts: Δ retired and negotiates that corp buys back 80 shares for $800 p/s Π (minority s/h) wants his shares bought back for same price but Δ rejects Π alleges that Δ breached fiduciary duty to minority s/h by not allowing him same

opportunity to sell s/h @ price

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Δ says that he does not owe duty to Π b/c corp can selectively buy shares (DGCL 160)

Holding (only applies to closely-held): Relationship between s/h in a closely-held corp must be one of trust,

confidence and finest loyalty (Meinhard v. Salmon) for the enterprise to succeed No duty to include other minority s/h in the sale of your stock BUT when you

include the company as a party it is unfair Notes:

Oppressive tactics/ freeze-outs: corp refuses to pay dividends, drain corp’s earnings in the form of exorbitant salaries and bonuses to the majority s/h, fire minority and since there is no liquid secondary market, it is impossible to sell

Applies only to actions in operations of the corp (like Sinclair and Amonson) If Δ had sold his shares to 3rd party then Π had no legal claim but since he

involved corp to the exclusion of minority In order to be w/in fiduciary duty the corp must offer each minority s/h the same

opportunity to sell a ratable # of shares to corp @ identical priceRemedy:

Δ give up $ he got for shares or corp can buy same # shares from Π at $800 p/s

Statutory provisions to allow corps to act like partnerships:NY has unified approach with defined shareholding characteristics

Allows corp to realign internal corporate governance to resemble a partnership Only non-publicly traded can use Corp can always use – no need to opt-in

NYBCL 620: (a) allows s/h to enter into agreements to govern how s/h are voted – no freedom of voting(b) Restricts management’s control or transfers all or part of management (resembles member-managed LLC)*must give public notice of quirky provisions

DE is a statutory close-corpDGCL § 341-356: integrated set of statutory provisions. Statutory close corporation: entity has to OPT-IN to a statutory scheme, as opposed to a close corp which may or may not have to be opted-in. In order to be a statutory close corporation, you must qualify AND have an affirmative election(a)(1): no more than 30 s/h. Stock must be subject to restrictions of §202 (s/h agrmt over governance and transferability of shares). No public offering of stock (nod to S corp)DGCL 343: election to have a statutory close corporation. You need to put in the title of the corporation and underneath, you must state that you are a Statutory Close Corporation. Certificate has to include any provisions under §342DGCL 342(b): allows you to set forth qualifications that people must meet to be a s/h (i.e. all s/h must be members of family). You usually become a statutory close corporation when you file, but under §344, you cannot have one after the fact unless you have a super-majority of s/h (66 2/3)

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Contractual Responses: Control1. Shareholder agreement: you can have provisions that commit contractually s/h to vote in one way or another and it is completely validDGCL 218(c) and NYBCL 620(a): cannot buy votes, but contractually committing people to vote with respect to a governance related issue. Remedy is specific performance in the event that a given s/h does not vote in accordance w/ agreement2. Irrevocable proxy: one s/h gives to someone else to allow that person to vote as he sees fit. Proxy can be irrevocable as long as it is stated that it is irrevocable and coupled with an interest (i.e. bank-pledgee-to secure a loan) DGCL 212(e) and NYBCL 609(f)Haft v. Haft: coupled w/ an interest if you have an interest in the corp that may support the irrevocable proxy3. Voting trust: separates the voting attributes of shares from the financial attributes. You must deposit the shares in a trust and the trustee is told how to vote sharesDGCL 218(a): voting trust will last as long as you want (not infinite but up till a date specified)NYBCL 621(a): maximum of 10 years with a 10 year option available

Contractual Responses: OwnershipBecause s/h of closely held corp desire to be in business together, s/h provisions prevent shares from falling into the wrong hands by either placing restrictions on transferability or forced resale provisions.

Restrictions on the transferability of shares:1. Right of first refusal: 3rd party makes offer and that triggers. Must first offer the shares to the corp or other existing s/h on the exact same terms. If the offer lapses or is declined then can sell to 3rd party. Reasoning: seller should be indifferent since he is getting the same amount regardless, but the shareholders are not indifferent. DGCL 202(c)(1)2. Right of first offer: differs from right of first refusal b/c of timing and solicitation. If you decide to sell you can’t go out and solicit from 3rd parties. You must offer your shares to the corporation or its s/h first. The s/h agreement states what the price of the shares will be or the pricing formula used.

Usually a combination of the right of first refusal and right of first offer, both may kick in. If the corporation declines the rights of first offer, you can go solicit other bids, but you have to offer the stock again under the right of first refusal. Only if the corporation or s/h decline again can you sell to a 3rd party

If 3rd party purchases the shares he will be subject to the same restrictions as original holder

3. Consent restraint: If there is a consent restraint there is usually not a right of first refusal/offer provision. You cannot transfer your shares w/out prior written consent of the corporation. The corp. can examine who you are selling to.

Consent restraints are most likely to be struck down by courts b/c it is unconstitutional to restrict rights to personal property

DGCL 202(c)(3)

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NY no statute but case law, Rafe v. Hinden, valid as long as consent is not withheld unreasonably

4. Group restriction: usually means that the other types do not exist. You can sell your shares freely but only to people w/in the group (i.e. family restrictions)

**Transfer restrictions do not trump the operation of law (i.e. divorce settlement – stock can be transferred regardless of transfer restrictions, or repayment of loans)**Legend: statement on the certificate that alerts prospective transferees that what they are about to buy is subject to transfer restrictions. Legend must be conspicuous and on the face and state that the shares are subject to the provisions. If legend isn’t on the certificate, then the buyer takes the stock and is not subject to provisions of which she is not aware. If she knows about them, they apply. DGCL 202(a) and NYBCL 8-204

Forced Resale Provisions:Requirements by K for a s/h to sell back her stock on the occurrence of a set of events, regardless if she is willing and able to continue owning them.

Events that trigger: termination of employment or death (the company receives the funds necessary to repurchase the shares from the estate through proceeds of a life insurance policy that the company took out on the deceased.

Biggest issue is price. Usually BV which is a conservative valuation – great for corp). BV = (TA-TL)/ # o/s.

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